- Nice rebound to end the week with low overall volume, but strong volume in key sectors
- Core PPI is in the sweet spot and looking for the CPI to get earnest about following it.
- Retail sales weaker just as everyone expected but no one cares to mention.
- The market is still extended in many respects with some iffy price/volume action of late, but the prior leaders are starting to move up again and with solid volume.
Friday doesn't put the pullback to rest, but there were definite bright spots.
The disappointing but expectedly so same store sales presaged weaker than expected April retail sales, and the actual numbers bore that out with sales overall down 0.2% (0.4% expected), flat when you took out massively weak auto prices. Based on some of the reactions to the report you would have thought unemployment was at 10%. The wholesale inflation data (PPI), however, dovetailed nicely with the sackcloth and ashes donned after this week's retail numbers. Core producer prices were flat month over month and fell to 1.5% annually. Many reasoned that if the CPI follows suit that will give the Fed the cover it needs to cut rates and stave off a potentially heinous slowdown (even, of course, as the more recent leading data suggests the economy is already picking up steam again).
That combination was enough to spark up futures a bit, though they were waffling heading into the open. The biggest fear among traders was that an early bounce would turn into another Thursday high to low sell off. Stocks rallied nicely up to midmorning and then the inevitable test came. The pullback held with moderate losses through lunch, then started back up. Just as the move higher got underway a story hit that terrorists had planned to attack US interests (soldiers, etc.) in Germany. That put the rebound on hold, but it did not lead to a sell off. In the last hour stocks sprinted higher into the close as some of that liquidity, seeing the market handled the bad news and was holding its gains, moved in to pick up stocks after that Thursday price thumping.
Nice price gains, good breadth and good leadership, but the volume was light. The move was dismissed by many because of the light trade, but there were some really good underpinnings. The volume was light, but it was concentrated in some of the rally's early leaders that spent the last run higher testing back to support. They took off on Friday. Energy, metals, industrials and chemicals enjoyed some great bounces on some serious volume. We were looking for these to rebound and on Friday they were doing just that, giving us some great buys, not to mention pushing many of our existing positions sharply higher as they continued their uptrends.
Technically the action was mixed as you would surmise from the above discussion. Nice intraday low to high action that fought off a mid-session negative in the German news story. It was a good answer to the Thursday selling, bouncing up off support levels and reclaiming some lost support with respect to NASDAQ and SP600. Breadth was excellent in response to the very negative downside breadth Thursday. The boogey man is that low overall volume. NASDAQ volume was excellent moving into the Thursday selling, then showed some distribution Thursday and a light trade rebound Friday. Not great action, but one distribution session in a run is not the end of the run. NYSE volume has been more questionable as it was overall low on the last run higher. It was lower on the Thursday selling as well, however, so at least it is consistent, i.e. not leaning one way or the other.
Despite the volume, we have to lean back on the good leadership that showed up Friday from sectors that had led early and tested and rested while the rest of the market posted the latest round of gains. Those strong early leaders are important. Their resurgence here shows money continuing to rotate around the market AND moving back into these stocks in a big way with very selective buys. You have to like that kind of money movement and its focus on specific sectors as it shows smart money is still in the market, still ready to buy and even at some higher prices.
Thus while overall trade was light and leaves the market subject to an additional pullback, some key early leaders were leading once again. That bodes well for the rally as it shows that money is still moving in, rotating to different sectors that are considered ripe for the buy after a pullback to consolidate. These early leaders can make moves higher while the rest of the market continues the pullback, making us money until the market pullback is done and other sectors are ready to make their moves again. Based on this action in these early leaders, it looks as if the market rally is not ready to go into a much deeper test at this juncture.
Is the PPI a precursor to a lower CPI?
The overall PPI was pushed higher by energy prices this time around as food prices posted their weakest gain in five months. Gasoline prices jumped 8% while food rose 0.4%, well off the 1.4%, 1.9%, 1.2%, etc. gains in the prior months. With gasoline jumping the overall PPI rose 0.7%, pretty much in line with the 0.6% forecast but below the 1.0% rise in March.
The core was, as always, the key. It was flat versus the 0.2% rise expected. That kept it flat for the second month and on a steady downtrend. Flat the past two months, a 0.4% February outrider, preceded by a 0.3% and 0.1% rise. That pulled the year over year rise down to 1.5% from 1.7%, matching the October 2006 level. Compare that to the 2.8% rise in core back in July 2005 that marked the decade high. Didn't we say pressures on prices peaked in October 2005? Go back and check; we sure did.
Regardless of what we said, the trend is lower even with intermediate and crude goods showing big gains year over year. These are not making it into finished goods. Auto prices are falling even as the input prices rise. They cannot pass the cost of the product onto the buyer. Boat manufacturers are trying to pass the costs along but as the forecasts earlier in the year show, buyers are not paying up and a weak 2007 is forecast, forcing boat makers to lower their prices.
This failure to pass along the price increases is a theme that recurs in every expansion. There is the ever-present worry that prices will be foisted upon buyers. The fear in the 1980's was a pass through. The fear in the 1990's was a pass through. It never happened. We always look for pass through when the economy is strong but it doesn't appear. McTeer and Laffer are absolutely correct: when an economy is growing and creating goods, services, jobs . . . the indicia of prosperity . . . supply meets demand. When DID we see pass through? In the 1970's when the economy was in malaise with no goods, services or jobs. Too much money without any supply creation exploded inflation as demand well in excess of supply allowed producers to pass on costs. Of course the money was worth less because of the rampant inflation, but the costs were passed on. Right now even with low pricing power in another expansion, companies are flush with cash. Now if the Bush administration would get off promoting a weak dollar those dollars would be worth a lot more. At least there is low inflation and thus the dollars we make are not being eaten up by inflation gains.
So does that means CPI will be lower? We believe so. It won't be at the 1.5% shown by PPI; consumer prices are not as low to start with and they have not fallen off the table. That said, prices are starting to fall at a faster pace, at least overall. No one month tells the entire tale, but as with PPI, CPI is on the trend lower. Inflation is still pesky, but inflation pressures continue to decline.
Leading indicators hit a 3 year high.
The economic recovery officially started in 2003 though we were writing of the robins on the lawn in late 2002 with respect to the economy turning the corner. The signs were there in the leading indicators but many were still talking about the woeful economic conditions. More recently the economy experienced a slowdown that started second half 2006. Of late, however, the economic indicators point to a recovery beginning to take hold even as many are still putting forth doomsday scenarios relating to the housing industry, a tapped out consumer, etc. Even with the solid turn up in the data, however, the pessimism remains.
Last week ECRI, the best man-made leading indicator, showed a solid increase, keeping the string of steady gains alive and well. This week the annualized growth rate rose to 5.2%, a three year high, leaping from 4.4%. Impressive. It also makes sense. After the surge in 2003 that saw GDP gain 7.4% in Q3 of that year, the expansion naturally slowed over the next two years though it was still expanding nicely. In 2006, three years into the recovery, it hit a slow spot. After that it is starting to come back. As it does, growth rates jump again. Thus the best leading indication in three years. With inflation falling (no doubt helped by the growing economic strength) this is a very positive outlook for the economy and thus the market. Why has the market been rallying? Because it was sniffing out this recovery.
By: Jon Johnson, Editor