U.S. stocks shook off some early session weakness on Friday, rallying midday and holding onto most of that momentum to the close.  However, three sessions of gains weren’t enough to deliver a positive week as the S&P 500 slipped 0.6% for the period. 

While for the day stocks were able to ignore an EU debt problem that isn’t going away until governments and investors bite the bullet and endure restructuring, for the week there was a clear sector rotation to safety as health care, consumer staples and utilities were among the best-performing sectors.   On the bond side, longer-term Treasury yields slid 20 basis points for the week.

Utilities, health care and energy led the broad market higher in Friday’s session.  Tech was the only of the 10 major industry groups to close lower, but financials also struggled as the sector barely managed a gain.

The day’s manufacturing reports were helpful to stocks as both industrial production for March and NY-area factory activity for April beat expectations.  However, the session’s CPI release, as had been the case with import and producer price reports over the previous couple of days, showed that commodity prices continue to eat into personal income.  Chained disposable income (adjusted for inflation and after-tax, so it’s even benefiting from the 2%-point reduction in the payroll tax implemented in Jan.) has been showing the effects.  The figure has declined from posting 2.7% year-over-year growth to 1.7% annualized over the past six months to a 0.2% annualized rate of increase over the past three months.  This seems to be an important development to me as we’ll see it in the spending figures. 

Market Activity for April 15, 2011

Sector Activity for April 15, 2011

The Dollar Index has managed to tick higher as of this morning, but really only because EU peripheral-government interest-rate spreads blow out, hitting the euro and the pound.  Those spreads have widened to record levels for Greece and Portugal as investors realize technical default is only a matter of time.  Irish government bond spread remain below the record 6.68 percentage points (668 basis points) vs. comparable German rates, but not by much.  The EU continues to attempt their ring fence strategy, keeping contagion from hitting Spain.  Sorry to say, the Spaniards will get hit by much higher borrowing costs too – the timing is the only question. 

Consumer Price Index

The consumer price index (CPI) rose 0.5% in March (in line with expectations), which follows three months of 0.4%-0.5% prints.  On a year-over-year basis, the CPI accelerated to 2.7% from 2.1% in February.

The completely worthless (for anyone outside of the Fed system) core CPI reading rose just 0.1% (shy of the 0.2% increase expected) as the rent, apparel, and personal computer components offset increases in other areas within the ex food & energy measure.  On a year-over-year basis, core CPI (again, this excludes those things that we need the most) is up just 1.2%. 

One can see why the Fed would concentrate on the core reading during most time periods as the food and energy components are volatile; thus removing these components smoothes out the data.  However, when you’re in an environment with which the prices of these components remain at high levels, there comes a time to pay more attention to the headline number – or is it that the core rate simply allows the Fed cover to continue on with its ZIRP/QE mad-scientist experiment?

So on headline CPI, price are up 4.7% at an annual rate over the past six months and a 6.1% rate over the past three months – ah, no problem there.  Maybe food and energy prices decline over the next couple of months and the inflation gauges fall back again, but maybe they don’t.  The Fed thinks the rise in these prices is temporary.   They may be right, but not for the reasons central bankers believe.  If their policy continues to keep these prices elevated, it will further eat into inflation-adjusted incomes and spending, therefore shutting down what is already a weak level of economic growth.  This would send commodity prices lower, but not exactly for a healthy reason. 

Empire Manufacturing

The NY Fed Bank’s gauge of factory activity within the second Federal Reserve district accelerated to a reading of 21.7 in April (expected to come in at 17.0) from the 17.5 print for March.  For perspective, the 10-year average is 10.6. 

New orders surged to a reading of 22.3 after slumping to 5.8 in March and the number of employees jumped to 23.1 from 9.1.  However, the average workweek fell 5 points to 10.3 (not sure how the workweek falls so much as the number of employees jumped – the new hires can’t all be part-timers).  Also, the inventory number fell to contraction mode, which suggests factories remains very cautious even with strong orders. 

And then we have prices, which continue to continue to rise.  The prices paid measure rose 4.5 points to 57.7, which is still well below the all-time high of 77.9 hit in the summer of 2008 when oil went to $145/barrel, but at the gauge’s historic highs outside of that 2008 surge. 

Industrial Production

Industrial production rose 0.8% in March (beating the +0.6% expected) after a upwardly revised 0.1% for February – a number that was initially reported as a 0.1% decline; upward revisions to manufacturing (up 0.6% instead of the 0.4% previously believed) and utility (down 3.6% instead of the 4.5% decline) output delivered the upward revision.

For March, manufacturing output rose 0.7%; utility output rose 1.7% (first gain in three months); and mining production rose 0.6%. 

Considering the manufacturing sector has been hot for 18 months and mining has surpassed its 2008 peak, it’s pretty amazing the overall industrial production index remains nearly 10% below the peak hit in 2007 – it just shows the previous cycle’s activity was driven by construction activity that wasn’t sustainable. 

Capacity utilization (the percentage of plant and equipment being used) also continues to rise, up to 77.4% from the 76.9% in February.  The long-term average is 80%. 

The importance of this is that the Fed has cited it as one of the key things they are watching in terms of what effects their policy decisions.  The figure remains a ways below that long-term average, but getting closer to removing one more data point that’s given the central bank free reign to keep monetary policy wildly aggressive.   The weakness of the economy will give the Fed plenty of reason to keep policy easy, but not this easy, not at these emergency level of rates; they’ve got to at least end ZIRP/QE and get fed funds back to 1.00%. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900