Goldman Sachs knocked the cover off of the ball, blowing by earnings estimates by 35%, but this was expected and failed to help financials, which were the second-most laggard behind telecom shares.
Earnings season in general has just gotten started, we normally don’t comment on things this early as less than 10% of S&P 500 members have reported thus far, but just to give you an idea profits are down 15% overall and -20% ex-financials. The expectation is for S&P 500 profits to fall 35% for the quarter.
Intel reported better-than-expected results after the bell last night and that’s got stock futures juiced this morning. But let’s get real here, when you set the bar low enough it’s pretty easy to hurdle. Intel’s operating earnings fell 31% and revenue was down 15% from the year-ago period. The market will eventually need earnings results to show final demand is improving rather than just the boost from cost cutting and we’re not seeing that yet.
Back to yesterday’s activity, consumer discretionary shares led the market higher on a better-than-expected retail sales report. We’ll get to the internals below, something that is very much out of vogue these days as the press knows only to focus on headline readings.
Industrial shares posted another good day, the second in a row as the 1% increase in the index that tracks these shares followed a 2.7% gain on Monday. Energy shares bounced too even though the price of oil moved below $60 per barrel.
The S&P 500 currently trades at 14.5 times earnings, which makes the current quote of 905 an appropriate top-end of this range in my view. This is an especially uncertain environment and it’s just tough to justify a multiple that is above the long-term average as a result. Some have argued that the market affords a higher P/E simply because the yield on the 10-year Treasury (currently 3.50%) is so low, this security offers the discount rate for most calculations – I’ve made this argument in the past.
However, the Fed is holding rates lower than they would otherwise be (and one cannot expect these very low rates to remain the case with the massive debt issuance that is coming) so the more appropriate rate with which to compare market valuation may be that of AA-rated corporates, which yields 6.15%. This puts the appropriate value for stocks at 16 times (or an earnings yield of 6.25% -- the inverse of the P/E ratio) , which is much more reasonable than the signal the 10-year Treasury yields is signaling of 28 times, which makes zero sense. (A P/E of 28 on the S&P 500 results in an earnings yield of just 3.57%, but it’s doesn’t take much to compare favorably to the very low Treasury yield environment, which is why a different measure, such as high-grade corporate yields, is more appropriate.)
Market Activity for July 14, 2009
Retail SalesThe Commerce Department reported that retail sales rose in June for a second-straight month, up 0.6% last month after a 0.5% increase for May. The ex-auto reading rose 0.3% after a downwardly revised 0.4% rise in May.
The headline reading was pretty much fueled by jumps in auto and gas station sales, up 2.3% and 5.0%, respectively.
Sporting and book-store sales (these two are combined into one component within the data) also posted a nice 0.9% rise; electronic stores registered a 0.9% increase as well. Online sales rose 0.6%, the first increase since January.
The housing-related components remained weak as furniture sales fell 0.2% and building materials were down 0.9%.
The eating & drinking component (largely driven by the relatively recession immune 20 somethings) fell 0.9% in June after two months of gain – 0.9%, either up or down, was a popular number in the June retail data.
The headline increase in retail sales will get people excited, but as we’ve seen with other premature spates of euphoria one needs to spend time on the internals of the data. The ex-auto & gas station number fell 0.2% in June and is down 6% at an annual rate over the past four months. Excluding gas station receipts alone, sales were up 0.3% for the month but are down 7.7% at an annual rate past four months. Retail sales ex gas, building materials and auto dealers, a number that feeds directly into the personal consumption component of GDP (GDP’s largest component), fell 0.1% and is down 1.8% at an annual pace for the second quarter.
While Q2 GDP will get some help from the trade data, as we touched on Monday, the biggest segment of the data (personal consumption) will weigh heavily on the figure.
Overall retail sales are down 9% over the past year and will not be able to sustain a meaningful rebound until the labor market begins to markedly improve.
Producer Price Index (PPI)
The Labor Department reported that producer prices rose at twice the rate expected, up 1.8% for June after a 0.2% rise in May. The figure was driven by a 6.6% pop in the energy component, which makes up 18% of the index – residential gas rose 2.5% for the month and gasoline jumped 18.5%. Energy will have the opposite effect on the data next month as the price of gasoline has dropped 17% over the past three weeks.
Other than energy the data remains tame, passenger car prices rose 2.0% in June, which is a large monthly move, but the three months of gain for this component is unlikely to continue. The one area I’m watching within the inflation gauges is the industrial supplies and machinery figures. We saw industrial supply prices within the import price data post a huge 10.3% increase in June and the capital equipment segment within PPI is one of the few spots that has posted an increase on a year-over-year basis. This is something to watch, at this base when the economy does rebound these areas will see prices explode to the upside.Business Inventories
The Commerce Department also reported that business inventories fell more-than-expected in May, down 1.0% vs. the estimate for a 0.8% decline. The liquidation of stockpiles will combine with consumer activity to put pressure on last quarter’s economic output (or lack thereof) – the reduction in inventories is not as bad as the previous quarter’s, but then again that was a record liquidation going back to when records began in 1947.
The sales data is beginning to look better though, falling just 0.1% in May, pressured by a 0.9% decline in manufacturer’s sales. Retailer’s sales rose 0.5% and the inventory-to-sales figure within the retail component is beginning to look pretty good again. It still has a little ways to go to get back to the two-decade lows of 1.45-1.48 months’ worth of supply, a level that may be necessary to make retailers more comfortable but the current 1.50 level shows that most of the work has been done in this regard.
On the other hand, manufacturing inventory levels, specifically on the durable goods side, remain too high for comfort in this environment and will continue to put pressure on production for a couple of months if sales don’t summarily bounce back.
Have a great day!
Brent Vondera
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