June Retail Sales Add to Constently Good News This Month

The Commerce Department released the Retail Sales Report for June, and the estimate-beating increase continues to add to the increasingly good news coming out in each of this month's economic reports.  The combination of strong economic data, strong corporate earnings, and a lower forecast on interest rate hikes continues to drive the market indices to record highs.  Finally, it appears that the market is reacting to data, not hype.

Today's report underscored significant strength in each of the key areas:

• Sales at retailers and restaurants rose 0.6%.
• Sales year over year were up 2.7%, although when you subtract out automotive sales and auto parts, that year over year number becomes 0.7%.
• Sales of building materials and gardening supplies were up 3.9%.

With the current earnings season ending its first week, the retail sales report is very good news as we await some of the major players to report over the next few weeks.  Yum Brands already lead the way in the restaurant industry, although their report was somewhat lackluster.  They beat on earnings by only $0.01 and missed on revenue by $90 million.  As we saw for the first five months of the year, though, the growth rate across the industry was extremely sluggish, only surging in the June numbers.  Underscoring that trend, Yum Brands increased their guidance for 2016 forecasting full-year core operating profit growth to be at least 14%, up from last year's 12%.  The retail numbers released this morning support that guidance.

In the Automotive industry, we use Ford (NYSE:F) as the bellwether.  They report before the open on the 28th.  We'll be watching the seasonably adjusted annual percentage rate of cars sold, which, if  the retail sales report is any indication, should be a decent quarter for the industry.  Also keep an eye on Magna International, (NYSE:MGA) a Canadian automotive parts supplier that does business worldwide.  Their earnings report typically provides a fantastic overview of the health of the industry across the globe.  Their earnings date has not yet been announced, but we expect it to be before the bell either August 5th or 8th.

The surge in building materials and gardening supplies should be excellent news for the large home improvement retailers like Lowes (NYSE:LOW) and Home Depot (NYSE:HD).  They report August 17th pre-market and August 16th pre-market respectively. 

In addition to the specific stock projections we can glean from these numbers, there is also the signal that consumer confidence is on the rise.  That boost in spending should translate into a healthy nudge for the GDP, and with interest rates remaining low, we should also see an increase in corporate capital expenses and a corresponding increase in hiring.  All-in-all, it was a very positive report, and it bodes well for the overall health of the current rally. 

Alcoa Kicks Off Earnings Season After the Bell on Monday

The Brexit vote is behind us, the UK's selection of a new Prime Minister is still two months away, the US election is still four months away, the Italian banking crisis is simmering, but not boiling over (yet,) and yesterday's jobs report has put both the specter of recession and of interest rate hikes on the back burner, at least for now.  So what's next?  Why, earnings season, of course, and right on queue, Alcoa (NYSE: AA) is poised to kick it off after the close on Monday, July 11th.

Alcoa is one of the companies we closely follow, not just to understand the commodity landscape, but because their earnings calls typically provide an outstanding view of most industries in the industrial sector.  They are heavily dependent, not just on commodity prices, but on the performance of major players in Aerospace, Transportation, Mining, Automotive, and a score of other industries that all contribute to orders of aluminum or aluminum based products.  Getting a bead on Alcoa's outlook on the first day of earnings season provides a tremendous amount of insight into how the remainder of the season will go for most other industries. 

This quarter's earnings call will be even more interesting, however, due to the impending split of Alcoa into two companies.  We expect to hear more regarding the timing of the split and additional details as to the quarterly and annual outlook for the new company, named Arconic and trading under the symbol ARNC. 

Since Arconic will be focused on the Aerospace and Automotive industries, ARNC will be added to our short list of quarterly earnings calls to study.  Remember, there are a handful of key earnings calls that you should follow to give a broad overview of each sector and the market as a whole, and AA (as well as ARNC when they go public) are in that category.

So, what can we expect on Monday?  Well, AA is traditionally pessimistic in their outlook, however this quarter they appear to have good reason to be.  In the first quarter of 2016, AA experienced a significant drop in after tax operating income both in alumina (40% y/y drop) and primary metals (26% y/y drop.)  Revenue year over year was down 15%, and you can expect those struggles to continue.

What's worse for AA, however, is that China - the world's leading supplier of aluminum - is gearing up to increase year-over-year production by 4%, and that increase is expected to begin in the second half of this year.  According to Goldman Sachs, that will drive the overall commodity price of aluminum down from $1692 per metric ton as of yesterday's settlement price to as low as $1350 over the next twelve months.

The value-added business, however, is expected to see a boost, and it's that area in which we'll focus our attention since it will tell us the health of other industries. Sales to aerospace and automotives have been growing at a healthy pace and that is expected to continue with some reports looking at 5% to 8% growth in that division.

Overseas, expect the strength of the US Dollar - especially following the post-Brexit surge against the Euro and the British Pound - to produce negative headwinds for the remainder of the year.  The strong dollar hurts exports and also hurts earnings exchanges as goods and services flow globally.  Expect the impact of the strong dollar to be referenced in the reports of most companies in the S&P 500, as most have significant exposure overseas.

Towards the end of the week, we'll gain insight into the Financial sector when J.P. Morgan Chase (NYSE: JPM) reports before the bell on Thursday, however that's a topic for another post.  Stay tuned.

A Neutral Fed Announcement Spooks Markets

The Federal Open Markets Committee (FOMC) issued a statement today that sent the US markets into a nose-dive.  With earnings across most sectors disappointing the markets throughout January, and with economic data being a further disappointment, speculation on the street was pushing estimates of interest rate hikes out into the September time-frame.  The Fed dispelled those notions this afternoon, and the Dow tumbled 190 points in response.

In today's release, FOMC stated, "Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy."  This is being interpreted as indicating a rate increase announcement no earlier than June, however it's not the dovish indicator the markets were hoping for.

It doesn't help that the FOMC's assessment of current economic conditions appears to be a bit rosier than those being seen by investors and traders.  Consider the following statements:

FOMC stated, "Labor market conditions have improved further, with strong job gains and a lower unemployment rate."  While it's true that unemployment has declined to about the 5.6% level, the Participation Index - a much more accurate measure of the workforce - has declined to its lowest level (62.7%) since 1978 and it continues to decline.  This would indicate that the number of eligible workers that are unemployed is increasing, not decreasing.  As to job gains, if you take Texas, Washington DC, Arkansas, and Utah out of the mix, the nation is actually shedding jobs at a rapid rate.  Almost all of the net national gains are coming just from the state of Texas.

Job Gains vs Unemployment

Here's the raw data just for Texas: Joint Economic Committee - Texas Economic Data

Next, the FOMC stated, "Household spending is rising moderately."  That's an interesting view, considering the Retail Sales number recently released was the largest decline experienced in 11 months.  If household spending is rising, one must question where they are spending it since it clearly wasn't in retail stores last month. 

They stated, "Recent declines in energy prices have boosted household purchasing power."  There's certainly more money in the consumer's pockets resulting from a decline in gas prices, however, as has been discussed several times over the past couple of weeks, there is no evidence that the consumer is spending that money.  In fact, there's evidence mounting that the decline in energy prices is about to have an extreme negative impact in the oil producing states that have driven the overall job growth since the recession.  With oil rigs closing, and oil companies starting massive layoffs, the conditions in states like Texas, Oklahoma, California, and North Dakota, among others, will quickly deteriorate.

Finally, FOMC stated, "Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices.  Market-based measures of inflation compensation have declined substantially in recent months; survey-based measures of longer-term inflation expectations have remained stable."  The problem with this statement is that both CPI and Core CPI are down.  This means that, even excluding food and energy, inflation is down. It makes sense, since wages are not increasing.  (Average in the latest release was a mere 1.7%.)  In other words, inflation is dropping, not because of energy prices, but because of a gradual softening of the economy as a whole.

What may have spooked the market the most is this phrase in their press release: "In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation." It's that "and expected" part that is disturbing.  Since their assessment of inflation to date is not accurate, the thought that they will react based on what they expect to happen implies a rate hike that will be premature in an economy that cannot tolerate it.

The only truly encouraging statement in the release is in the very last sentence: "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."  This is, from what we can determine, the only acknowledgement that there are global economic forces that are providing extreme headwinds to US economic growth.  The strength of the dollar, a crumbling European economy, the renewed threat of a Greek Crisis, and the evaporation of Russia's economy are enough to give even the most bullish investor pause.  Add to that a reduction in the rate of growth in China and India, and there's the prospect of a US economy barely able to sustain forward momentum.

We're nearing the end of this quarter's earnings season.  There are definitely very strong sectors that will provide excellent trading opportunities in this uncertain market.  Aerospace, Auto Parts, and Utilities are all looking pretty good right now.  Keep an eye on the remaining announcements, and trade into strength (or short into weakness, if that's to your liking.)  For now, though, expect volatility to remain high given the uncertainty around when the Fed will decide to move on rates.

Union Pacific Sees US Economic Growth; Cites Several Uncertainties

The overall theme of strong US economic growth in 2015 continues with Union Pacific (NYSE: UNP) forecasting strength in several key domestic arenas.  With 31,838 route miles providing rail access to and from both the Pacific Coast and the Gulf Coast shipping ports, this 150 year old railroad corporation has the inside track on a wide range of industrial and consumer goods being transported around the nation.  What they are forecasting for 2015 is very promising on the domestic front.

Agricultural demand looks strong in the US, although there's oversupply internationally so demand for US agricultural products overseas looks weak.  There is also some short-term weakness evident in demand for ethanol - which will impact demand for corn - however with plunging gas prices in the US, demand for ethanol is forecast to increase as we head towards higher demand for gasoline through the first half of this year.

For those interested in the automotive sector, the news on that front continues to be positive.  UNP saw continued strength in consumer demand for both finished products (i.e. new cars) as well as increased demand for automotive parts.  They see this trend as continuing into the 2015.  Seasonally adjusted, shipments of new cars in the 4th quarter increased by over one million vehicles.  Shipments of parts also saw a 2% increase in the 4th quarter. 

On the energy front, strong demand for coal continues to be forecast.  Inventories are currently low, and UNP expects strong demand to replenish those supplies.  The price of natural gas, however, could put pressure on demand for coal since a lower natural gas price will decrease the demand for coal across the nation.  While UNP has yet to see this impact in their shipment orders, they have called this out as a concern for their coal segment in 2015.

The price of crude oil is already having an impact on shipments, and that's expected to continue into 2015.  Volumes in the Bakken fields are down significantly already, and as long as crude prices stay below $75 to $80 per barrel, declines there will escalate.  The Uinta Basin and Niobrara Basin have increased shipment volumes, however I'd be concerned about Niobrara maintaining that trend.  The Uinta Basin produces traditional natural gas and oil, and is increasing overall production while decreasing the number of rigs, primarily through horizontal drilling.  The increased volume per rig is currently able to offset the impact of decreased margins, although if prices remain low, that will not be enough to sustain profitability.  The Niobrara Basin, however, has a very high exposure to margin risks associated with shale extraction - the most expensive of the oil production methods in use today.  Low oil prices will cripple production in this basin.  This will also have an impact on UNP's shipment of frac sand which accounted for 35% of their 28% increase in non-metallic minerals volume in 2014.

Switching to the construction industry, UNP is seeing sustained growth in the shipment of construction materials and they expect that to continue into 2015.  This growth is in both residential and non-residential building materials, and it's also being seen in lumber shipments. 

Intermodal shipments continue to grow domestically as well.  This is of interest since intermodal shipments transcend the various transport providers including trucking, rail, and shipping.  There's weakness being felt in imports, however, due to the long-running labor dispute in the west coast ports.  A much-hoped-for deal in mid-2014 didn't manifest, and the impact is being felt along the coast.

UNP reported strong demand for imported beer in 2014, and they forecast increased demand in 2015.  I'm not sure if there's a trading opportunity here, but in the interest of full disclosure, I will state that I'm doing my part to ensure demand remains high.


UNP did cite several uncertainties in their 2015 forecast, but by now they are uncertainties of which we are all aware:

• Crude oil prices will impact multiple industries, especially if they remain this low for any length of time.
• Global economies are softening, primarily in Europe, Japan, and Russia.  China's growth has slowed, (although it's projected to be close to 7% in 2015, so that's still a significant amount of demand.)
• The west coast labor dispute will continue to add import pressures.

Based on UNP's assessment of shipment volume projections in 2015, keeping an eye on the automotive industry and the construction industry should provide some interesting trading opportunities.  On the speculative side, it's worth keeping an eye on the interaction between coal and natural gas demand as the energy price dynamic plays out through the first half of the year.