U.S. stocks rallied Friday to close the week higher for the second-straight week (S&P 500 up  as the day’s economic data reduced expectations that recession is upon us and EU officials stated they’re devising a new bailout plan – yes, just a day after the previous proposal was finally ratified.  As we’ve been calling that plan “a day late and a euro short,” it appears each new proposal remains behind the curve. 

All the high cyclicals led the market higher as energy, basic materials and tech outperformed.  Telecoms, consumer staples and health care lagged, but did close higher as well. 

European stocks also advanced on the news but bond markets didn’t play along with the positive sentiment as even France (which is supposed to be a backstop country) saw its bond spreads (relative to German bunds) jump to all-time wides.  Spain and Italy saw their spreads widen again too as S&P cut Spain’s credit rating.

The latest rally has pushed the S&P 500 just a touch above that 1220 level that has been resistance since the market began to fall apart in early August.  So we’ll see if it’s up, up and away now that the breakout has occurred.  If this latest bounce though is all about the hope that Europe gets things right, I’m afraid the market has set itself up for yet another fall.  

Market Activity for October 14, 2011

Sector Activity for October 14, 2011

Bail Out Du Jour

The bailout plan of the day supposedly involves that 50% haircut on Greek debt we’ve been talking about (deeper losses for investors, which includes the banks) and will also propose using the EFSF to backstop banks by providing them with the capital they need via equity stakes – of course this is necessary since the banks can’t raise capital on their own; there’s very little appetite to touch bank equity right now, largely because in raising capital (issuing more shares) investors’ stakes get diluted in the process.  

Probably the most daunting task is that they’ve set a deadline for October 23 to get this new plan done.  Considering it took three months for the eurozone to ratify the July 21 proposal that was suppose to solve the problem, this will be quite interesting to watch.  On top of it all, the whole basis of this plan assumes that a debt problem can be solved with more debt – the EU bailout fund is exactly that, a debt instrument.  Anyone who thinks this is a solution is, to put it kindly, kidding themselves. 

Import Prices

Import prices remained sticky in September as the monthly increase came in at 0.3% (expected to decline 0.4%) and the year-over-year number accelerated to 13.4% from 12.4% in August.  This is largely a function of the weak dollar and it shows the additional difficulty facing the U.S. consumer. 

Retail Sales

Retails sales came in much-better-than expected for September, up 1.1% (expected at +0.7%) and the August result was revised up to +0.3% from the 0% previously reported.  Excluding autos, sales were up 0.6% (double the expectation) and core retail sales were up 0.6%. 

It’s that core number that matters most for the GDP reading and it looks pretty good, up nicely for the quarter – at least on a relative basis as the prior two quarters were very weak. 

The internal numbers looked good.  Granted, price increases have driven these results to some extent – GDP adjusts for prices – but still based upon the things the consumer is dealing with still good.  Autos led the overall reading as those sales rebounded after declining in August; furniture, clothing, and eating & drinking all looked good too. 

We’ll have a better feel of the extent to which prices drove the number higher when we get the CPI data for September on Wednesday.  If that number comes out at the expected 0.3% increase then core retail sales will still have increased 0.3% for September, but for the quarter will be very close to flat.

Confidence

So the nominal retail numbers were was up strong in Septembe but consumers continued their dismal outlook as the latest confidence reading dropped in October from an already very weak number from September. 

The University of Michigan’s consumer confidence gauge fell two points from September-October to a reading of 57.5 – second-lowest reading of the year and back near the lows we saw in 2008-2009. This is a preliminary number; we’ll get the final print in two weeks. 

Business Inventories

Business inventories rose 0.5% in August, which also beat expectations – although the report also showed that sales cooled to a 0.3% rate so a little inventory build there. 

Unless we get a big inventory number for September, it doesn’t look like this component is going to offer much boost to Q3 GDP.  Further, if the GDP report calculates inflation at the rate CPI has (it has its own inflation gauge), then consumer spending isn’t going to offer much help either.  It appears that economists are expecting 2.2%-2.5% growth for the quarter.  I think this estimate is set up for disappointment.  

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Have a great day!

Brent Vondera, Senior Analyst