By Joseph Hogue, CFA
While the markets will almost certainly be down on Monday as investors lament over the surprisingly weak non-farm payroll report, there is still reason to believe that the rally in equities will remain intact.
March employment numbers finally showed the weather-related adjustment that I have been warning about over the last month. Payroll numbers from December through February have surprised to the upside by around 50 thousand per month as construction and retail were both particularly strong. The unseasonably warm weather pulled forward much of the spring-time boost in housing and kept people out shopping more than is typically expected. Friday's surprise by about 80-90 thousand will probably be the biggest adjustment, but analysts will most likely be revising their April estimates downward as well.
The adjustment, as well as a large number of foreclosures coming to market, may mean short-term weakness in the housing market and related companies. I detailed the risk and ways to ride out short-term volatility in an article last week.
Manufacturing Still On-Track
Factory orders came back strong in February with a 1.7% increase after a small decline in January. Equipment and software spending has been particularly strong and should add to first quarter GDP. The ISM manufacturing index beat expectations slightly at 53.4 against 52.4 in the month prior. The employment picture within the report was strong as well showing further strength in the jobs picture.
The non-manufacturing ISM report was marginally weaker than expectations at 56.0 but still showed a fairly strong sector. The financial services and construction components saw a pickup in activity along with a strong showing in employment.
The trade balance numbers will come out on Thursday. Weak export growth to Europe and China and strengthening demand for foreign goods from a rebound in jobs has driven the trade deficit up sharply over the last year and will continue to detract from GDP. High oil prices have started to moderate demand for fuel but not to the point of weakening growth.
Consumer prices, out on Friday, will gain the most attention this week. February's gains of 0.4% were the largest in 10 months and helped to lower expectations of further quantitative easing by the Fed. While the Fed believes the rise in fuel prices is temporary we cannot deny the affect on consumption and retail sales. The consensus is for a 0.3% increase in CPI with risks pointing to a surprise pickup on top of last month's reading.
Despite the rebound in the Unites States, data from Europe and China continues to show weakness going forward. Both the services and manufacturing eurozone PMI reports have shown the region firmly in contraction. While the official Chinese manufacturing PMI surprised to the upside, and above the 50.0 demarcation for growth, the HSBC PMI report slipped for the second month and came in well below expectations.
All Eyes on China
The big news outside the U.S. this week will be the slew of data out of China on Friday. Trade and consumer prices are reported earlier in the week, both forecast to moderate somewhat from last month. A slower rate of inflation will help investors overlook what will probably be slower GDP growth on the hopes for increased stimulus out of the People's Bank. Consensus is for first quarter growth to come in at 8.4% versus 8.9% in the prior quarter.
Yum Brands (YUM) should do well as the Chinese government attempts their transition to a consumption-driven economy. The $32.5 billion fast-food restaurant operator is expanding aggressively in emerging markets with much of it focused on China. Food prices continue to keep costs high but first quarter earnings should get a boost from favorable currency translation as many currencies strengthened against the dollar over the quarter.
Large mining companies like Freeport-McMoran (FCX) may get a boost from data out of China. Even if GDP data comes out weaker than expected, the government is widely expected to enact further stimulus measures in the second quarter which should boost commodities. The miner of copper, gold, and other minerals trades at 7.9 times trailing earnings and pays a 3.3% dividend yield. Investors may want to buy half their allocation before Friday's economic data and wait to see how the shares react at the end of the week.
First Quarter Earnings
Alcoa (AA) will kick off the first quarter earnings season on Tuesday. The aluminum producer is forecast to lose $0.04 per share on the quarter against a three cent loss last quarter and a gain of $0.28 in the same quarter last year. While bulls like to point out a relatively cheap valuation of 13.4 times trailing earnings, the shares are less attractive at 20.1 times forward earnings. Sluggish global growth and continued oversupply may mean another couple of quarters before the stock is ready for investors.
Bears are calling for a slowdown in overall earnings growth for the first quarter. While margins have been strong through cost cutting over the past couple of years, companies are now having to look for earnings growth through sales. Companies selling to the improved U.S. market may be able to meet expectations while exporters to international markets may not do as well. Industrials and consumer discretionary should do well relative to other sectors.
Investment in energy and master limited partnerships (MLP) should do well as U.S. manufacturers see a strong rebound. A previous article outlined an energy portfolio providing strong dividends and diversification while benefiting from tax-advantaged status of MLPs. Many of the energy MLPs are pipeline operators, meaning their revenues are tied more closely to volume than price. Even as energy prices increase or decrease, volumes stays relatively consistent and distributions remain stable.
Linn Energy (LINE) pays a stable distribution of 7.4% and is fairly protected from volatile energy prices through volume pricing and 5-year hedging contracts on natural gas. The company has completed a little over $4 billion in acquisitions over the past two years making it an extremely strong player when the market for natural gas does rebound.
Disclosure: I am long LINE.