“I like narrative storytelling as being part of a tradition, a folk tradition.”
-Bruce Springsteen
Life imitates art and consistent with tradition, the earnings season is all about corporate storytelling and stocks trading on headlines – remember, fat fingers rule the world! So far the 2Q10 earnings season is no exception and if the trend continues, it’s going to be a long hot summer.
The S&P’s 6.0% rally since the July 4th holiday has been about the second quarter earnings season and how good the numbers are going to be despite continued signs that global growth is slowing. The signs of a renewed or intensifying economic downturn continue to mount and this will manifest in Q3, not Q2… Yes, Intel had a great quarter, but that is in the rear view now.
I realize that Alcoa’s management team had to put their best foot forward about the demand environment, but growth is slowing and they appear to be speaking out of both sides of their mouths. The quarter that AA reported was potentially a bearish indicator of what’s to come; prices up and demand down, by any other name that is stagflation. There is the potential that AA management has set themselves up for a Toll Brothers “You-Tube” moment. To recall, this is how things went for Toll Brother last quarter:
“It appears that our business has finally emerged from the tunnel and into a bit of day light.”- Bob Toll, CEO May 26, 2010.
Then three weeks later:
“In the three weeks following our earnings conference call on May 26, 2010, our per-community deposits have been running about 20% behind the comparable period in last year’s third quarter and our per-community traffic has been about 3% behind.” -Joel Rassman, TOL CFO, June 16, 2010.
No matter where you look in the USA or abroad the news continues to point to trouble ahead. Here are some data points about American Austerity at the state level that can’t be ignored:
(1) By the end of June, the backlog of unpaid bills in Illinois could exceed $5.5 billion
(2) Most of California's 240,000 state employees could see their salaries temporarily cut to the federal minimum wage.
(3) Minnesota is delaying tax refunds
(4) State tax revenues fell 12% from Sept 2008 to 2009
Who gets hurt the most by these trends? The consumer.
As I said earlier, the signs of a renewed or intensifying economic downturn continue to mount, highlighted by the weaker than expected June retail sales (June represents the second straight month of declining retails sales) and a worse than expected May trade deficit.
On a year-to-year basis, June 2010 retail sales were reported up by 4.8% from June 2009, continuing a trend of slowing annual growth, versus a revised annual May gain of 6.8% (previously 6.9%) and a revised 8.7% (previously 8.9%) annual increase in April. The annual numbers are working off the effects of the severe decline in economy last year and are somewhat meaningless.
The slowing retail sales numbers suggest that the upcoming second quarter GDP "advance" estimate due to be reported on July 30th will show the economy slowing further. The sharp deterioration in May’s trade deficit also suggests a meaningful widening in net exports, also a negative for GDP.
Sadly, the "advance" GDP number is largely a guess by the BEA. In order to maintain consistent data series, the BEA is measuring the same types of supply-side data that they first developed in the middle of the previous century. Bottom line, someone sitting in Washington is guessing how fast our economy is growing (or contracting) based on a method developed in the previous century. This is just plain wrong and is a clear indication that the government data cannot be trusted to accurately show what is happening in the real economy.
As we said on our Q3 theme call, we are below consensus for GDP growth in 2H10. Yesterday’s retail sales data and other upcoming reports should continue to be on the downside of expectations, as the fall-off in business activity begins to accelerate despite what the corporate story tellers are saying. Yesterday, the FED agreed with this call, but they still don’t have it right.
With respect to the FED forecast adjustments, the upper and lower bounds of the central tendency forecasts for 2010 GDP (Q4/Q4) were each lowered by two tenths (now 3.0% to 3.5%). The upper bound for 2011 was lowered from 4.5% to 4.2%, but the lower bound was lifted a tenth to 3.5%.
The unemployment projections for year-end were little changed (9.2% to 9.5%), as the lower bound was lifted just a tenth; although the range for 2011 was raised by two tenths to 8.3% to 8.7%. Policymakers appear to be resolved to a somewhat slower pace of labor market recovery. Similarly, core inflation forecasts drifted slightly lower for 2010 (now 0.8% to 1.0%), 2011 (0.9% to 1.3%) and even 2012 (1.0% to 1.5%).
If the “fat fingers” want to trade another negative headline based on slowing economic data, they will get a chance today - Industrial Production is due out. June industrial production is expected to be -0.1%, consensus was previously at a 0.2% gain. May was reported at a gain of 1.2% (1.3% prior to revisions). Consistent with other economic data out of Washington, until the consensus begins to catch up with the weakening reality, reporting risk continues to be to the downside of expectations.
On Friday, the Hedgeye retail team will host a conference call that will provide further evidence that demand may be on the cusp of deterioration, exacerbated by a housing double dip. To listen to that call please email for more details.
Function in disaster; finish in style
Howard Penney
