It is fascinating to watch irrational exuberance at work. People seem to always be jumping on bandwagons, grasping at straws, and driving stock prices up or down for no rational reason. So it was on Wednesday, Thursday, and, then, again, in the morning on Friday. By the end of the day on Friday, of course, some measure of reality prevailed and many of the retail and building company stocks that had started skyrocketing, had fallen back to earth, at least somewhat.
The insanity started Wednesday morning, with the release of "better than expected" durable goods orders. Orders for non-defense capital goods rose by 4.8%. The vast majority of this increase was composed of ultra-volatile transportation sector goods, like airplanes. Boeing has now seen the cancellation of about seventy 787 "Dreamliner" orders, and the drop in such orders will surely take a toll in June (see here). Excluding transportation, durable goods orders increased only by 1.1% in May. More important, that increase reflects replenishment of drawn down inventories, rather than demand increases. But, no one was thinking too deeply, it seems, and people were in the mood to have a party.
On Thursday, Bed, Bath and Beyond (BBBY) announced relatively good earnings numbers. They didn't turn in a great performance, but it was very good, given the terrible state of the economy. Part of the credit must be given to the lucky (for them) fact that their main rival, Linens & Things, has gone bankrupt. Management has also been much more aggressive than other retailers in the area of cost cutting. All in all, management deserved a "pat on the back", and it got one, with the increase in their share price.
Nothing about the BBBY announcements, however, supported a vast increase in the stock prices of other retailers. The sparkles of good news were specific to Bed, Bath and Beyond. For example, not all retailers are cutting back. Some, amazingly enough, are opening new stores into the midst of the depression, increasing their costs dramatically by doing so. Most important, not all retailers are lucky enough to have a bankrupt main competitor, at least not yet. Indeed, some of the retailers whose stock soared may be the next to go bankrupt. Only the deep cost cutters will survive this shaking out.
The government helped, by announcing, on Friday morning that, in May, personal income rose 1.4% from the month prior. This was then heavily spun by some of the "business" media, into part of the "green shoots" or economic recovery argument. As far as I can see, however, there aren't any real green shoots. There are mostly brown weeds on the horizon, as far as the eye can see. Let me explain what I mean...
The truth is that most of the rise in income was government largess, particularly billions of dollars worth of $250 checks that were issued to Social Security recipients. These checks are a one-time deal, and the stimulatory effort, will be removed in June, when no checks will be received.
Thursday also gave us the earnings report of a “down and out” home builder, Lennar Homes (LEN). They managed to squeak out a terrible, but "less horrible than it could have been" earnings report. For people grasping at straws, that was enough cause to start bidding up building company stocks. Forgotten was the fact that the company lost a heap of money, is in terrible shape, and gave every indication that there is a very good chance that things will get worse. The fundamentals for both retail and home building could not be worse. But, when did that ever stop a Wall Street rally?
Month to month income figures showed a 1.4% rise, but year over year the increase was merely 0.3%. Most important, the critical income and spending number was lurking in the background, but mostly forgotten. The locomotive behind sustainable spending is always "wage and salary income". This critical forward-looking indicator fell 0.1%. That's a very bad sign. Year over year consumer spending decreased by 1.8%. That is a dramatic decrease which is poison for retailer earnings, going forward. Yet, in spite of this reality, retailer stocks went up wildly on Friday morning.
Perhaps, huge numbers of manic-depressive denizens of Wall Street forgot to take their lithium tablets. Had they been thinking clearly, they would have seen that the core personal consumption expenditure index (PCE) increased by 1.8%. Yes, that means it cost more to buy things -- inflation. When both the spending decreases and cost increases are considered, the actual amount of goods and services that consumers bought decreased by 3.6%.
Meanwhile, the statistics are showing that people are saving more of their income, and controlling their spending, because they are frightened. The individual savings rate went up, and that's a good thing for the American economy over the long term, but not for retailers or builders. The average person is now earning 1.5% less (inflation at 1.8% minus the year over year wage increase of 0.3%).
Investors must have taken their pills before the end of the day on Friday. Perhaps they were suddenly able to see a deeper reality, and this caused them to pull back. The numbers I've just rattled off, are valid only if the U.S. government reports are valid. Economist John Williams thinks otherwise. He runs a website known as ShadowStats.com, and presents rather compelling evidence showing that government inflation numbers are heavily gimicked to the downside. If the numbers are recalculated to remove the gimicks, using a pre-Clinton formula from the early 1980s, inflation is running at several percentage points higher than the government admits.
If that is true, and it appears that it is, the decrease in consumer spending and spending power is several percentage points more severe. So, the situation is much worse than the dismal one I've already described.
Everything is very negative for retailers and builders. As Lennar pointed out in its report, there has been a huge rise in long term interest rates. This, combined with fast rising unemployment, continued foreclosure activity, and impending resets on pick-your-payment mortgages will severely impair consumer spending and hurt both home building and retail. If we then add in the fact that the S&P 500 has just finished breaching its 200 day moving average on Wednesday, we have a recipe for deeply falling markets.
The overall market looks bloated. Retailers and builders look even more bloated. It appears likely that we will see a deep fall in stock prices which will challenge previous lows. That isn't necessarily a bad thing. It would help bolster the value of the dollar, and assist the government in selling bailout bonds.
Disclosure: Not long or short on any stock mentioned by name in the article.