Jim Farrish's  Instablog

Demand destruction is the new buzz word to describe the current price increase in food and energy. What exactly does it mean? In simple terms, the higher prices rise - demand falls. The average consumer has a price point at which they refuse to buy a product or service. Gasoline at $4 per gallon in 2008 showed the average driver would cut back and we are seeing the same today as demand for gasoline has declined with the rising price. Food costs have escalated and consumption has been cut. The rise in gasoline prices is estimated to be an additional $750 per year per car assuming 15,000 miles driven. If the average household owns two cars the impact is $125 per month. Average that across the population and the number shows the potential impact to the US economy. Higher prices do and are impacting economic growth.

Retail sales data showed a 0.4% increase in March versus the 0.5% increase in February and 1.1% rise in January. The trend is declining. Factor into the data that gasoline sales are a part of the report. The higher price of gasoline is having a direct impact on both gasoline sales and consumer retail. Some analysts are now looking at growth slowing to 1% on GDP. We have seen the numbers revised from 3% to 2% over the last quarter, and Bank of America revised their estimate to 1.5% last month. Rising energy and food prices are showing signs of slowing consumption, regardless of what the Federal Reserve states.

Commodity prices have started to decline from their high. The first sign of this was shown in sugar and other soft commodities. The latest signs have been in the price of crude dropping more than 5% from the high. Base metals have seen price erosion as well. Alcoa dropped more than 6% following a positive earnings announcement as the guidance was less than expected. Translated – they see demand destruction as a result of higher prices.

Some of the blame for the recent pullback in retail, energy and other commodities has been given to quantitative easing part two expiring in June. Perception being the market is pricing in a shift by investors relative to risk. There may be plenty of truth behind this theory and we will know soon enough, but the fact is prices are facing resistance from the end consumer and there is plenty of hope and belief there will be no QE3, leaving the markets to trade on traditional supply/demand theory. Without the easy money in the system from the Fed the market will be vulnerable to more volatility and the reality of having to stand on its own two feet.

If the market is to resume its uptrend it will need to see a rotation in leadership back to technology, banks and retail. The challenge will be to overcome a negative sentiment towards technology stocks. The perception is negative as chip stocks have disappointed. There are pockets of tech that remain positive such as internet and cloud related stocks. Riverbed (RVBD) announced better than expected earning results pushing the stock up 12%. More good news from earnings in tech could help the leadership shift. Banks are in a similar funk relative to investor sentiment. JP Morgan (JPM) beat estimates and offered solid guidance, but the stock fell 1% as grumbling about the mortgage related business surfaced again. Retail has been on of the leaders and thus far the earnings picture is positive. If the trio along with other areas can maintain a positive lift from earnings the uptrend will continue. If the negative cloud remains, the trend lower will accelerate as the previous leadership from energy and commodities will add to the downside move.

The wild card remains the consumer relative to inflation and demand destruction. The new buzz words paint a clear picture of what will be the driver, up or down, for the markets near term.