Economic Notes – April 21, 2014


Written by: Jon McGraw

Economic data in the industrial production and retail sales areas, in particular, was stronger than expected, and fueled hopes that the cold winter doldrums are behind us in favor of a more ‘productive’ spring.  In a short week, markets gained on decent earnings reports as well as better-than-expected economic growth in China.

(-) Retail sales for March came in stronger than expected, gaining +1.1% compared to consensus estimates of +0.9%, and the report also featured upward revisions for the prior two months of the year. The core sales number, removing the more volatile areas of autos/gasoline/building materials/food services, rose +0.8% compared to an expected +0.5% gain. The breakdown of components included solid gains in ‘general merchandise’ (this covers the department stores as well as Targets/Wal-Marts of the world), non-store retail (online) and furniture. In the headline figure, gas station sales fell on lower prices, while building materials sales rose, so these largely offset each other. Compared to the first few months of the year, improved weather last month certainly contributed to the better figures, as many expected they would.

(-) The Empire Manufacturing Index for April came in at +1.3, which disappointed relative to the +8.0 expected and March’s +5.6 reading. New orders and shipments both fell, but employment improved by a bit, and planned capex expenditures rallied several points, which is encouraging from a forward-looking perspective.

(+) The Philly Fed manufacturing index reached +16.6 for April, its highest level in some time, up from +9.0 last month and beating expectations calling for +10.0. Shipments, new orders and employment all gained, and inventory improved somewhat (although remaining in the negative due to a slowdown in accumulation). While it appears regional in focus, the Philly Fed index has been an important and widely-watched leading indicator of economic performance with results typically similar to the ISM.

(+) Industrial production for March rose +0.7%, which was two-tenths higher than forecast, including a +0.6% adjustment higher for Feb. Output in the natural gas and mining sectors were the biggest contributors, while auto production fell almost a percent (even though this was a planned seasonal outage). Capacity utilization, which is the ratio of used-to-available productive capacity in the U.S., rose four-tenths on the month to 79.2%, beating expectations of no change. We continue to move in an upward trend towards normalcy, as seen in the chart below. For sake of context, the historical average for this metric is 80.1 (1972-2013), with results during that time falling into a range running from a low of 66.9 in 2009 to highs of over 85 on a handful of occasions (1973, 1979 and 1989). Based on common thinking, if this metric gets above 80, then companies are almost running ‘too efficiently,’ and will begin to increase capex to get additional capacity and/or add workers. Then, if the number creeps toward the mid-80’s or higher, worries start to surface about over-production and possible inflationary influences. As you can see, though, the range of outcomes here is quite tight, so tenths of a percent are the usual variance from month-to-month.

(0) For March, both the headline and core versions of the Consumer Price Index rose +0.2%, compared to an expected +0.1% increase for each. This brought the trailing 12-month numbers for the headline to +1.5% and core to +1.7%. The largest component affecting the release was a pickup in shelter costs (combined rent of primary residence and owners’ equivalent rent up +0.13%—small numbers are all we have when inflation is this low), with core goods not far behind, which was concentrated in clothing and used cars. On the headline side, recent drought conditions pushed food prices a bit higher for the second consecutive month. Overall, though, tame from an official inflation-measuring standpoint.

(0) Business inventories in February rose a tenth of a percent less than expected, up +0.4% on the previous month. Retail inventories were unchanged, bucking the prior trend, while auto inventories declined several tenths, bringing down the overall index.

(-) The April NAHB Housing Market Index rose a point from March to 47, but underwhelmed consensus of 49. Expected single family sales moved up a few points, while present sales and prospective buyer traffic were flat. Regionally, the Northeast gained several points, while the South was flat and Midwest and West fell several points. Despite some weather improvement, this index hasn’t seen much of a corresponding change.

(-) Housing starts for March rose less than expected, gaining +2.8% to 946k versus consensus expectations of a +7.0% increase. The weather played a role here, too, as starts in the Midwest gained significantly, while those in the South fell (more of an impact with more building taking place in that region in recent years). Single-family rose +6%, while multi-family fell -3%. Building permits fell -2.4%, which also disappointed versus an expected -0.4% drop.

(0) Initial jobless claims for the Apr. 12 rose just slightly (by 2k) to 304k, which was still better than the 315k expected by consensus. No special factors were reported, other than a few quirks for seasonality adjustments related to spring break employment. Continuing claims for the Apr. 5 week fell to a post-recession low to 2,739k, compared to an expected 2,780k. Claims are moving in the right direction…lower…albeit slowly as weather headwinds improve.

(+) The Fed’s Beige Book, which anecdotally outlines economic conditions around the twelve Fed districts, showed a strengthening of activity after a few months of weather-related sluggishness. Expansion was best described as ‘modest to moderate,’ with 10 districts showing improvement (two better than last month’s book). These were seen most directly in consumer foot traffic and spending, manufacturing and transportation as firms caught up with shipments caught up due to winter storms. Commercial loans also grew in most districts, while residential loans did not and looked choppier across the country.

Investors are listening to Janet Yellen’s remarks closely these days as she makes her imprint onto Fed policy. A speech she made at the Economic Club of New York was apparently important enough for the news to cover, but didn’t offer any real surprises. Her continued mentioning of continued slack in labor markets and ‘considerable’ low fed funds rate levels post-taper was soothing to markets.

Market Notes

U.S. equity markets were up strongly in the shortened week, with better economic data and a few earnings reports that surprised on the upside.  In terms of sectors, energy and industrials led the way, up 3-4%, while utilities and telecom lagged, but still gained nearly 2%.  Large-cap and small-cap ended up roughly in line.  As of Friday only 80 firms in the S&P had reported earnings, 40% of which were positive, but is typical of this point in the reporting cycle (in the past few years, early reporters have been less robust than later reporters).  This coming week will represent the biggest group.

In developed foreign markets, Japanese stocks rallied mid-week to a 2% gain as the nation’s finance minister laid out a plan for investing additional government pension assets in equities to help offset the expected low return from domestic bonds going forward—this naturally had a positive stock market effect due to the higher implied demand.  The U.K. and Europe ended up with positive returns to a lesser degree.

In emerging markets, China’s 1st quarter GDP came in mid-week at a level of 7.4%, which, although a drop relative to last quarter’s 7.7%, it was a positive surprise to many who feared something nearer to (or below) 7%.  Russian equities fell on heightened tensions, but negotiations to delay sanctions led to a recovery later in the week.  Other EM nations were generally lower as well, with a slightly stronger dollar.

Bond returns were off in the ‘risk-off’ week, with the exception of high yield and floating rate bank loans, which gained a few basis points on the week.  Worst-performing, unsurprisingly, were long-term treasuries and mortgage-backeds.  The middle of the yield curve was affected more than the edges.

A stronger dollar was negative for most foreign bond sectors, and pushed the majority into the negative on the week.  Emerging market debt held up a bit better than developed markets.

All global real estate returns were in the positive, led by industrial/office and retail in the U.S., while Asia lagged with only a percent gain.  Mortgage REITs lost ground in line with higher interest rates.

Commodity returns were up about a percent on average (as measured by the DJ-UBS index), and were led by gains in the agricultural group—wheat and soybeans in particular, the former based on increased tensions in Ukraine (a major wheat producer) and late freeze conditions in the Midwestern U.S, which threatened harvests for winter wheat.  WTI crude oil prices gained around a percent on the week to end near $105, which seems to be a point of technical resistance.  Gold and precious metals declined several percent—Tuesday was the biggest loss of 2014 so far—as news from China indicated demand for the metal may be falling further.

After its semi-annual meeting, the IMF released its most recent global economic report and outlook for the coming year—overall world growth is expected to rise from 3% last year to 3.6% in 2014 and 3.9% next year, led by emerging markets with 2014 growth pegged at 4.9% and 5.3% next year.  Despite volatility in these markets, they remain the world’s growth engine.

Have a great week!