Weekly Update: Vacation time
This summer’s drought now encompasses more of the country than at any time since 1956, with the USDA almost daily further slashing already meager forecasts for corn, soybean and wheat, pushing futures to record highs. This is prompting concerns that higher food prices will hit consumers at a very inopportune time, when they are heading back to stores for the back-to-school season. The back-to-school season has taken on added urgency this year, as retail sales through June have fallen three straight months, undermining the key driver of the economy and causing second-quarter GDP to tail off from the first-quarter’s already subpar pace (more below). But there are indications that the food-price-spike worries may be overdone. This is because unlike energy inflation, which is quite volatile and until recently had been pulling back from its late-winter/early-spring surge, food inflation is more stable and slow moving. The USDA says only 20 cents of every dollar spent on food makes its way back to the farm—the bulk goes to marketing—and the price impacts typically don’t start showing up for months. It’s anticipated that food inflation could rise 0.6% at year end, not devastating. Also, because food only accounts for 14% of total consumer expenditures, the impact on CPI inflation should be muted. Thus, the drought’s shock is seen as temporary and unlikely to spur any additional Fed accommodation when policymakers meet next week.
It may be a different matter next year, with the USDA projecting food prices to jump by as much as 5% in 2013, with beef being hit the hardest and smaller hikes expected for milk, eggs, poultry and pork. Moreover, just the perception that prices are rising can affect consumer psyches and behavior; everyday buyers of fresh summer produce and vegetables already are feeling the pinch, and this morning’s final take on University of Michigan sentiment suggested consumers are feeling less secure about their future (more below). But this week’s jittery markets likely had little if anything to do with drought and everything to do with Europe, where various gauges of economic health pointed to worsening conditions. The UK economy shrank by 0.7% in the second quarter, much worse than expected and the third successive quarter of contraction, leaving Britain in its longest double-dip recession in more than 50 years. Germany’s Ifo index suggests its economy is grinding to a halt. And in Spain, yields on two-year notes rose to less than 100 basis points under the 10-year, and five-year notes actually are above, undermining Spain’s ability to sustain its finances. A three-month ban on short selling all stocks likely will worsen liquidity. (Short-sale bans in late 2008 didn’t stop the bleeding.) Elsewhere, Greek two-year yields are priced at 26%! Greek officials are now talking about what they are experiencing as a Great Depression.
The markets were relieved this week when European Central Bank President Mario Draghi made reassuring comments about the ECB’s willingness to purchase sovereign debt as many of the eurozone’s key players were heading off. Germany Chancellor Angela Merkel has left Berlin for her usual two- to three-week August vacation. French President Francois Hollande is headed to the South of France. Belgian Prime Minister Elio di Rupo is going to Italy. And German Finance Minister Wolfgang Schaeuble is on the German North Sea Island of Sylt. (I’m taking off myself to visit various ballparks with the Mister.) The news in Europe helped lift the spirits of a market amidst a so-so earnings season. With more than half of S&P 500 having reported, companies are beating earnings estimates by 3% on average, but corporate guidance is rapidly deteriorating and 61% have missed revenue expectations, the highest percentage of revenue misses since the first quarter of 2009. Meanwhile, fourth-quarter operating estimates are still reflecting year-over-year increases in the high teens—ISI Global can’t recall a gap this wide between future earnings expectations and the perceived global path ahead. It would seem something has to give. I’m looking at that window for signs of its closing, but I’m not going to worry about that now. (Nor is Merkel, Hollande, di Rupo or Schaeuble, apparently.) I’m going on vacation.
Positives
It’s too early to worry about recession The government’s initial estimate said second-quarter real GDP rose 1.5%, a bit better than expected. Services growth was encouraging, as was residential investment. The core PCE deflator indicated benign inflation. Also, real GDP growth was revised up for the period for the preceding four quarters, indicating an economy that has been a little healthier than what was reported. Other reports this week also suggest modest growth. The Markit flash PMI for July remained in expansion territory, a sign next week’s manufacturing PMI likely will remain so as well; the Chicago Fed National Activity Index rose slightly; and jobless claims fell sharply for the fourth time in five weeks, dropping the 4-week average to its lowest level since March.
Housing is contributing Zillow’s quarterly home-price gauge rose for the first time in five years, and the FHFA purchase-only home price index has now risen in five out of the past six months, indicative of a recovery that has broadened from multi-family starts to include more single-family starts and stable-to-higher home prices. Both new and pending home sales unexpectedly fell, but analysts blamed a shortage of lower-end houses. The ratio of new/existing homes for sale versus the U.S. working-age population is at 40-year lows, and NAHB Housing Index is at a five-year high. A pick-up in housing’s leading indicators typically is followed by strong equity performance.
It will help if China ramps up Recent data from China suggest acceleration in economic growth in the second half of the year. Notably: Markit’s preliminary manufacturing PMI rose this month by the largest amount in almost two years. Home prices increased in 39% of the 70 cities tracked by the government in June, the largest share in nearly a year. Yuan loans outstanding grew in June by the largest amount since 2009. This is evidence that monetary easing and stimulus are starting to pay off for China. The markets have priced in a soft landing for China; getting something better could be a catalyst.
Negatives
This is what makes me the most uneasy The flight-to-safety trade from distressed EU sovereign debt toward U.S. and other haven currencies has pushed those rates down to record or near record lows. Here in the U.S., the five-year Treasury yield made a new all-time low; the yield on the 10-year Treasury dropped below 1.40% for the first time and the yield on 30-year bond also touched a record low. The domestic fundamentals and credit ratings suggest that those haven rates should be as much as 1.75 percentage points higher than they currently are—unless they actually are reflecting the future direction of the economy. Gulp.
Capital expenditures slowing June’s above-consensus increase in durable goods orders—the second straight monthly upside surprise—masked growing weakness in capex. Ex-aircraft orders, nondefense capital goods orders fell a third time in four months, reflecting the recent economic weakness and increased uncertainty over the outlook. On a year-over-year basis, capex orders are up 1.8%, the least since January 2010.
Consumers in a funk The final take on University of Michigan sentiment for July rose slightly to 72.3, but remained below June’s final read and well below May’s high for the year. Concerns about weak income and job growth are weighing significantly on confidence, while a growing number also are expressing worries about the pending fiscal cliff, with 45% reporting unfavorable perceptions of government policy. This is not the sort of reading that bodes well for this year’s critical back-to-school sales season.
What else
Not all things about Spain are bad (and we’re not just talking wine) Government debt, at 72% of GDP, is lower than the euro-zone average of 88%, and lower than even Germany and Austria. Yields on outstanding debt are still sustainable, with an average interest rate of 4.1% and average maturity of 6.4 years. And, Spain has done this before in the early 1990s, when Spanish yields were higher than they are today and the unemployment rate was over 20%.
Intended consequences? McDonald’s says the company and its franchises may have to pay up to $420 million a year to comply with the Affordable Care Act. It’s expected each outlet will have an additional $10,000 to $30,000 in annual costs, the amount varying because of the number of employees per restaurant and their employment status.
Let the games begin! Since 1948, the average stock market performance during summer Olympic Games since has been +1.2% for the S&P. Also, with UK’s economy contracting again, this is a repeat for London, which in 1948 hosted the so-called “Austerity Games.”
