Pick your poison: Crimea or China. One is a geopolitical black swan, the other an economic black box. Crimea could be more disruptive in the near term, while China's uncertain economy likely entails more long-term risk. Crimea and China are worrisome, but also emblematic of the wall of worry up which this bull has so nimbly capered.
A world away from Putin's puppets or China's shadow bankers, U.S. economic data has been quietly improving after weather-impacted winter data. Some of the data, such as retail sales, are tightly U.S.-focused; other reports, such as producer price index, have both an international component and a currency component. We will continue to underscore the importance of earnings to the stock market's continued upward progress. With more of our trading partners doing better than are doing worse, and with the trajectory of exports also on the up, we remain confident in our 9% EPS growth target for 2014 and with our projection for high-single-digit to low-double-digit appreciation in the S&P 500 this year.
Not So Quiet Overseas
Russia's Putin likely watched the U.S. response to Syrian weapons of mass destruction (zero popular and Congressional interest in intervention) and determined he could move with impunity in Crimea. With the Tea Party rather than Bush-Cheney-Rumsfeld leading the GOP, and with Democrats focused solely on domestic damage control after the shaky Obamacare launch, Russia has had free reign in Crimea. The markets have adjusted to the new political reality quickly.
Mr. Putin will not catch the world napping again should he decide to reclaim other Russian-majority regions. If pro-Russian forces wander off the Crimean peninsula into Ukraine proper, seeking to "liberate" more pro-Russian neighborhoods, we expect global tensions to rise and stocks to decline. If Putin simply consolidates his gains, Crimea could quickly become last month's news. We do not view Crimea as comparable to Neville Chamberlain's Czechoslovakia.
China's shadow bankers have been using copper as collateral on loans. Copper is in free-fall now that it is being proscribed from that use. However, we do not view China's economy as being in free-fall. China's leadership is correct to let some air out of the economy before it pops like a balloon, as it threatened to do before needed reforms were implemented in the banking system.
Mildly Encouraging Domestic Data
March has included a mix of February and January data; but even the January data has for the most part been better than anticipated. March kicked off with January construction spending rising 0.1%, better than the consensus call for a 0.4% decline. A 0.8% decline in January public construction spending masked growth in private construction. January private construction spending rose 0.5%, led by a 1.1% gain in residential projects. December was revised up to 1.5% growth, so January's sequential gain was all the more impressive.
February's nonfarm payroll gain of 175,000 has been much picked over, but we're focused on the 0.4% gain in hourly earnings. In the past year, average hourly earnings are up 2.2%. Bureau of Labor Statistics data shows the annual rate of change in average hourly wage growth slowing from 4% in 2007 to little more than 1% by mid-2012. While 2.2% is not a spectacular gain, hourly earnings must continue moving higher to incorporate more workers into the consumer economy.
On that note, February retail sales showed encouraging 0.3% growth, better than the 0.2% consensus and reversing the revised 0.6% decline in January. February marked the first gain in monthly retail sales (seasonally adjusted) since November. Retail sales does not count spending on home services such as utilities and heating. The spending trend was thus positive enough to overcome higher-than-average spending on home heating in a savage winter. As home heating spending retreats along with winter's chill, consumers could redirect disposable income toward home goods such as appliances and housewares.
The second-tier data points largely ignored by the market sometimes provide insight that is overshadowed in the crush of events from, say, Crimea. Export prices increased 0.6% in February, and also increased 0.6% excluding agricultural goods. Import prices in February were up 0.9% month over month, but were down 0.2% excluding fuel costs.
The year over year change in import prices is a decline of 1.1%. One way of looking at is that we are "importing deflation," perhaps enough to reduce pressure on goods pricing sufficient to offset the moderate but accelerating gains consumers are enjoying in annual hourly wages. While imports are detractive to U.S. GDP growth, exports are additive to GDP. The 12-month change in export prices is also negative, down 1.3%. Lower pricing positions U.S. exported goods to compete more favorably in overseas markets.
The pattern in producer price and consumer prices captures these favorable pricing trends. February producer prices were down 0.1%, while core PPI (less food and fuel) dipped 0.2%. The consensus had looked for 0.1%-0.2% gains in both measures. The Consumer Price Index advanced 0.1% both for all-items and for core. When the economy revs up and interest rates begin to rise, as they started to do in mid-2013, investors immediately fret that the Federal Reserve has "fallen behind the curve" of inflation. Annual rate of change in export and import prices and trends in PPI and CPI suggest that despite higher rates, inflation is as yet a toothless threat.
The Empire Manufacturing index reached 5.61 in March, rising from 4.48 in February though missing the 6.0 consensus; readings above 0.0 in this diffusion index signal growth, while readings below signal contraction. According to the text accompanying the release, "…business conditions continued to improve for New York manufacturers, though activity grew slowly." This measure of New York State manufacturing activity was in a downtrend through much of the back half of 2013, so the upward reversal is encouraging. Investors track the Empire Manufacturing index to get an early read on the ISM Manufacturing index, a measure of national industrial activity.
The data from mid-March onward has been particularly promising. U.S. factory output rose 0.8% in February, rebounding from January's weather-impacted 0.9% decline and rising the most in six months. Overall industrial production, which combines manufacturing with activities at utilities and mines, increased 0.6% in February, much better than the 0.1% forecast and the strongest seasonally adjusted monthly change since September. Output at utilities moderated from January's high-single-digit increase, suggesting that the gain in February was largely from manufacturing and mining. Capacity utilization edged higher to 78.8% from a prior 78.5%, without yet threatening the 80% level - which sets off inflation alarm bells.
February housing starts, at a 907,000 SAAR (seasonally adjusted annual rate), were little changed from the (upwardly revised January reading of 909,000. But building permits, an indicator of future construction, increased 7.7% to a 1.02 million SAAR and grew at the fastest pace since October. The permits data in particular bodes well for the house hunting season, because new homes ripple through existing home sales as consumers move up. Existing home sales were in line with expectations.
The Philly Fed index trounced expectations, in a positive sign for the Delaware Valley. The Leading Economic Indicators index also topped consensus. Durable goods orders rebounded from a negative January reading. And the final reading on Q4 2013 GDP was nudged higher, to 2.6% from a prior 2.4%.
Not every data point was bullish. The uncommonly cold and snowy weather in January and February weighed on builder confidence. The NAHB Housing Market index came in at 47 in March, missing the consensus of 50 though edging up from 46 in February. The National Association of Realtors' pending home sales index fell to its lowest level since October 2011. The winter weather was so severe this year that it may be distorting housing-related data. But the trend in interest rates may also be weighing on housing overall.
Consumer sentiment, however, seems to be bouncing back. Early in March, the University of Michigan Consumer Sentiment survey fell to 79.9 in March, down from 81.6 in February. But the Conference Board's Consumer Confidence reading of 82.3 sharply surprised on the upside, trouncing the consensus call while rising to its highest level since June 2008.
So far, the indicators are spring-like (certainly more spring-like than the actual weather). Industrial activity is accelerating. Reduced export pricing supports further growth from record export levels, suggesting our trading partners are healthy on balance. Despite negative sentiment, retail sales data suggests that consumers are spending; wage growth, albeit tepid, should be a further positive for consumer sentiment.
Jim Kelleher, CFA, Argus Director of Research
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.