Thoughts on the weak retail sales number
I am on BNN in Canada today at 1215 ET to talk about matters financial. So as a lead-in to what I am going to say there, I wanted to write here about the retail sales numbers, earnings season and the economy.
Retail sales were weak. The headline showed a 0.5% decline for June, this coming after a 1.1% decline in May. Obviously, this is not going to be supportive of economic growth. Parsing the data for the trend however shows that much of the weakness was due to energy as the core is up 4.5% ex-energy on a year-on-year basis. So while we are still a ways off peak sales, retail sales are up more than 7% from the nadir early in 2009. All of which is to say that the economy has recovered since 2009. We don’t feel it because a technical recovery isn’t a real recovery without employment growth.
On the other hand, earnings season has been pretty good so far. And stocks have rallied as a result. I think much of this owes to technical factors, of which liquidity may be one (see David Rosenberg’s comments via FT Alphaville). Now I mentioned on Monday the day before the rally began that technicals were bullish. But I tend to weight heavily to the fundamental side and the retail sales numbers demonstrate that the economic fundamentals are soft. I agree with John Hussman that this is a market to rent more than one to own.
But the question comes up: why are earnings beating if the economy is soft? A reader who noticed this juxtaposition, asked about this recently. Here are some of my thoughts.
It is a bit odd that earnings reports of American companies are coming in so much better than the economic data but I think there are a number of factors which help:
- Companies have record profit margins in part due to squeezing costs via technology and outsourcing. It’s no coincidence that margins are high but employment has yet to rise significantly. I would say margins are high because employment costs have yet to rise significantly. Just last week, I noticed that Safeway had an electronic checkout lane, for example. These are the kinds of innovations which depress American employment and incur a one-time cost but boost productivity and profits. (But, of course, profit margins are mean reverting because high margins invite competition and competition erodes margins.)
- Companies are international so their earnings are not dependent only on US consumers. Alcoa and Intel are examples here. These companies both beat – and not just because of US business investment.
- Companies do play games with the numbers. They want to beat numbers as insiders’ stock options depend on it. CEOs understand that their share prices have momentum; missing numbers can break upward momentum.
I’d like to see where the banks are starting this Friday. Meredith Whitney expects weakness, especially at the broker/deals like Morgan Stanley and Goldman Sachs. Since I follow this sector closely, I will be interested to see what the banks say regarding credit, margins and dividends. The signalling effect of the dividends is key. If we see a decent report from, say, Citigroup and a dividend from JPMorgan Chase, this could have a positive impact on all shares because the financial sector is very important psychologically for the market these days.
Bottom line: retail sales were weak. The economic data we have seen of late – manufacturing, employment, personal income – all suggest a slowing in economic growth. But, if companies put in a decent quarter of earnings, shares can rally. Nevertheless, anticipated earnings growth into 2011 is very high given already record profit margins. Unless economic growth picks up, this growth is unlikely to be met.