Daily Insight

U.S. stocks gave back about two-thirds of the prior session’s rally, after a very weak retail sales report for October came in below expectations and led many to believe the holiday season will be the worst since the early 1980s. I think there are some positives that are being ignored right now, but surely we’re headed for several months of weak activity from the consumer.

Stocks began the session lower after the release of that retail sales data, but rallied hard into the afternoon session as it looked we were headed for another late-session rally – recall stocks spiked in the final two hours of Thursday’s session. Alas, it was not the case as the G20 began to roll into Washington and the uncertainty that revolves around such a summit may have caused traders to think twice about going long into the weekend.

We’ll touch on the summit below, but it’s enough to say for now that one should always set expectations low when 20 or more leaders get together. Heck, G7 meetings prove feckless, getting 20 together (especially when this includes Russia, Argentina, South Africa, Brazil and Saudi Arabia – countries that do not have a track record of engaging in activity for the common good) turns the group into a financial United Nations – a group that is hardly united.

Crude

Oil futures continue to plunge, falling to $55.69 per barrel as I type, and gasoline prices now fully reflect the decline we’ve seen in the wholesale price. We’re hearing predictions of $35-$40 per barrel – I wonder how many of these forecasters were those calling for $200 just five months back – but this is probably unlikely. On a daily basis we see production cuts from various locations across the globe and this should put a floor under crude prices. Further, when the 111th Congress takes the helm, their explicit desire to reinstate the ban on offshore drilling will also have an effect.

The Economy

The Labor Department reported import price fell in October by the most on record, coming off of an extreme elevation, as plunging commodity prices pushed the index lower. This was largely due to the fuels components as petroleum products slid 16.7% in October.

Excluding petroleum, import prices continue to come lower but remain three times higher than the 20-year average. (Note, natural gas is not considered petroleum products within this report, so the 4.9% decline in the price of nat gas last month held the ex-petro figure back; it would have hardly budged if nat gas were considered a petroleum product.)

This illustrates even the slightest bounce back in energy prices will keep the overall figure elevated and non-fuels prices are higher than the data actually states. And we should not forget, inflation is a monetary phenomenon. Massive liquidity injections by central banks across the globe will likely cause all commodity prices to rise again looking 6,8,12 months out. Further, as mentioned above, it appears Congress is dead set on reinstating the offshore drilling ban, so we’ll continue to import a large percentage of out energy needs, unfortunately. This will not help import price activity 12 months out as the continuation of large energy imports and potentially higher prices for this energy combine.

In a separate report, and the big one of the day, the Commerce Department reported that retail sales fell 2.8% in October, which is the largest decline since these records began in 1992. Ex-autos, sales weren’t much better, falling 2.2%.

We have now endured four-straight months of decline in retail sales, also the worst since records began. The damage has really taken hold in the past two months, and we have to go back to the final two months of 2001 to see a similar degree of weakness.

We’ll note that most of the weakness of not just the past month but also for this four-month stretch is due to the plunge in gasoline prices and auto sales. Gas station receipts in particular are down 12.7% for October and roughly 16% since July. When excluding auto and gas-station receipts, retail sales fell a relatively mild 0.5% in October. For this four-month stretch of weakness, total retail sales have slid 5.3% (nearly 16% at an annual rate), but just 1.7% (5% at an annual rate) when adjusting for auto and gas-station sales.

Don’t get me wrong, consumer activity is weak as has been the case since July. All components were down, except for the eating and drinking – surely a lot of drinking going on out there – and health stores components. But the bulk of the weakness is due to autos and price-related declines in gas-station receipts. Possibly some of the savings from the plunge in gasoline prices will show up the November and December retail data as this should mildly help the holiday shopping season – emphasis on mild.

Lastly, the Commerce Department reported business inventories fell more than expected in September and the prior month’s reading was revised down a bit. This will result in a downward revision to the third-quarter GDP report.

The sales data fell 2.0% in September and followed a 2.2% decline for August, reversing the strong rebound witnessed in the second quarter. The 12-month change has gone from up 8.3% in July to just 3.3% after this latest report.

As a result, the inventory-to-sales ratio continues to climb and we should expect the figure to hit 1.35 months’ worth of supply over the next few months. Still, stockpile levels were so low that even a pronounced increase will leave inventory levels relatively low.

This is a major positive. So long as public policy is not destructive (higher tax rates, regulations, destroyed trade pacts, failed stimulus efforts – big ifs I guess) the economy should be able to snap back from this weakness in relatively quick order. Massive cash positions and streamlined structures within U.S. corporations will also help. The next two quarters of GDP reports are going to show the level of economic weakness mirrors the true recession of 1990-1991 at least ( I say true because the so-called recession of 2001 was a downturn, not a conventional recession) and possibly approaches something as bad as the 1981-1982 recession – the credit event of the past three month was just too much to take. But even if Washington signals tax and trade policy will remain unchanged (as lower tax rates and expanded trade pacts are highly unlikely) the business-side of the economy will catalyze economic activity two quarter out. For the fourth quarter of 2008 and the first three months of 2009 the damage has already been done.

G20

The Group of Twenty convened in Washington on Saturday, after they rolled in via their 10 car (none hybrids from what I saw) entourages and enjoyed first-class dining compliments of the U.S. taxpayer – I’m sure people like Russia’s Medvedev thanked you.

I’ve got to say though, while the summit produced only ideas of future cooperation, many of the topics discussed surpassed my low expectations. Things like transparency and standardization within the credit default market and the importance of free trade (actually warning against the protectionist mistakes of the past) where pleasant to hear considering we generally get nothing but growth-killing regulatory regimes from these gatherings. We’ll get a better idea of what will come of it when the group gets back together in March.

It does appear, by the pressure on futures this morning, that many may have expected some policy action to immediately follow the summit. This thought ignores reality and in our opinion the meeting should be viewed a success that we didn’t get anything untoward from this group – yes, the expectations were that high.

Have a great day!
Brent Vondera, Senior Analyst