David Joy: Momentum slows with start of second quarter

Our thoughts and prayers are with the victims of the Boston Marathon bombings. This senseless tragedy reminds us of how precious life and freedom are, yet also how fragile they can be. In the days following this kind of event it is difficult to focus on the more mundane aspects of our daily lives, as such things suddenly seem so much less important. Understanding that, investment markets continue to operate and it is our responsibility and privilege to continue to share our analysis.

Stocks tumbled on Monday, suffering their worst daily loss since last November. The 2.3% decline in the S&P 500 came on the heels of falling prices last Friday, although that move was relatively less significant. But Friday’s move did come in response to two economic reports that raise questions about the current state of the U.S. consumer. The first of these was the March retail sales report, which at -0.4% was even weaker than the anticipated flat reading, and the weakest since last June. Some of the decline came about as a result of lower gasoline prices at the pump, itself a good thing, helping to offset spending cutbacks elsewhere in the economy. But even accounting for that, spending softened. To be sure, the monthly data is volatile. In February spending rose 1.0%, while in January it fell 0.1%. But the report does raise questions about how consumers are reacting to tax increases associated with the fiscal cliff resolution and the federal budget cuts in connection with the sequester, which took effect on March 1.

Perhaps the prevailing assessment of consumer resiliency in response to these developments was a touch optimistic. Such newfound skepticism was reinforced by the second economic report from last Friday, the April preliminary University of Michigan’s consumer confidence survey. Once again, rather than the expected flat reading in comparison to last month, the survey fell to its lowest reading since last July.

Taken together, these reports seem to show a consumer sector still adjusting to changes in the economy, and taking a somewhat more cautious turn. And coming on the heels of the disappointing March employment report, economic momentum as we exited the first quarter appears to have slowed. Each of the past two years has been characterized by a pattern of relative economic strength in the first quarter, followed by a slowdown in the second. It has been widely anticipated that a slowdown might be avoided this time around. But after these latest reports, and some recent relative softness in manufacturing and home sales, new questions are being raised about whether this pattern will be repeated once again this year.

The market reaction to these reports last Friday betrayed the same uncertainty. Stocks fell, but compared to some other asset categories their decline was modest. At the sector level, however, the most economically sensitive groups fell sharply. Materials lost 1.5%, energy lost 1.3% and industrials fell 0.6%. In contrast the defensive sectors saw renewed buying interest. Commodities, on the other hand, tumbled. Copper fell 2.7%. Aluminum fell 2.3%. West Texas intermediate crude oil fell 2.4%. Gold fell 5.0%. Bond yields fell. The yield on the ten-year U.S. Treasury note fell seven basis points to 1.72%. The thirty-year bond yield fell from 3.0% to 2.92. Credit spreads widened slightly.

As trading got underway this week, we witnessed a repeat and intensification of Friday’s pattern. Some of the price weakness is undoubtedly attributable to a carryover of sentiment from Friday. But some was also attributable to a weaker than expected first quarter GDP report from China. In particular, commodity prices once again came under severe pressure, with energy, metals, and grains all falling sharply. Stocks were weak across the board as well. It should be pointed out that most of the day’s declines were already reflected in the day’s trading when the bombings in Boston occurred with roughly an hour of trading yet to go, although there was some additional selling thereafter into the close.

The economic calendar for the remainder of the week in the U.S. contains a few data releases that can sway sentiment in one direction or the other, but not unequivocally. The NAHB index on Monday was somewhat weaker than expected, but on Tuesday March housing starts were stronger, and building permits declined. On balance, a somewhat mixed result for the housing. Later in the day, industrial production and consumer prices are scheduled for release, to be followed later in the week by the Fed’s Beige, and leading indicators. If these reports are also generally on the soft side they will serve to reinforce the newfound concern over the pace of activity as we begin the second quarter. Whether that is enough to overshadow first quarter earnings reports remains to be seen. As with last week, financials are very much in the spotlight this week. Citigroup and Goldman Sachs have already delivered results that exceeded expectations, and Bank of America, American Express, and Morgan Stanley are among the notable names also on the earnings calendar this week. Also reporting are Johnson & Johnson, Intel, Coca Cola, Verizon, Google, IBM, Microsoft, General Electric, and McDonald’s, along with many others. So far, according to research firm ISI, 31 companies in the S&P 500 index have reported first quarter earnings so far, with 64.5% exceeding expectations, slightly below the long-term average of 66%.

Corporate CEOs have been a little more upbeat recently in their expectations for the economy in the months ahead. But, the recently softer data may cause some to temper their enthusiasm when offering future guidance in connection with their earnings reports. Both the Dow and the S&P 500 came very close to punching through nice round numbers in their respective index levels on Thursday of last week, 15,000 for the Dow and 1,600 for the S&P. But both pulled back in response to the weaker data on Friday. Whether they can mount another attempt anytime soon will likely require some stronger economic data, and some improved momentum from first quarter results.

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The NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as 'good,' 'fair' or 'poor.' The survey also asks builders to rate traffic of prospective buyers as 'high to very high,' 'average' or 'low to very low.' Scores from each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.

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