Companies Grapple With Pressure from All Sides
By Chris Maxey, Ryan Davis
November 20, 2012
Hurricane Sandy Distorts Economic Data
Equity markets continued their downtrend last week, as fiscal cliff worries and tax-related selling weighed on stock prices. For the week, the S&P 500 and Dow Jones Industrial Average declined 1.5% and 1.8%, respectively. The S&P 500 is down more than 7% since the Federal Reserve announced QE3 on September 14.
The Federal Reserve released minutes from the FOMC meeting held on October 23-24 last week. The transcript was notable due to discussion surrounding the scheduled year-end conclusion of Operation Twist, whereby the Fed sells shorter-term Treasuries to finance the purchase of long-term Treasuries. In the minutes, “a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program.” Market participants undoubtedly will welcome the continuation of $45 billion in Treasury purchases per month.
Economic data generally improved last week, although Hurricane Sandy wreaked havoc on several reports as the storm disrupted economic activity in the Northeast in late October.
On Tuesday, the National Federation of Independent Businesses reported its monthly Small Business Optimism index. The index improved slightly from 92.8 in September to 93.1 in October. The primary takeaway was a record-high reading in the percent of owners uncertain about whether business conditions will be better or worse in six months. Survey participants, polled before the presidential election, were uneasy due to the broad range of outcomes associated with the elections, taxes, and the so-called fiscal cliff.
Weak sales is still the top problem reported by small business owners, closely followed by taxes and government regulation. The overall index remains historically weak, compared to the pre-recession average of 100. NFIB Chief Economist Bill Dunkelberg expressed concern that the reading has failed to reach 95 in the 40 months since the financial crisis ended.
Retail sales disappointed in October after contracting by 0.3%. According to the Census Bureau, which compiles the report, the hurricane had “both positive and negative effects on the retail sales data. Some firms reported a drop in sales due to permanent or temporary store closures….On the other hand, some firms reported sales increases due to significant supplies for the affected areas…” It is difficult, then, to ascertain the true nature of the October data due to these disruptions. Given the previous strength in the third quarter, a bit of softness was not totally unexpected. Economists had anticipated a slight decline of 0.1%.
Inflation data was fairly muted in October, with both the Producer Price Index and Consumer Price Index coming in fairly soft. Producer inflation actually declined month-over-month, falling 0.2%. This compared to expectations for a 0.2% increase. Energy and food had little impact on the headline index, as core PPI came in at the same 0.2% decline.
Consumer inflation was slightly firmer, rising 0.1% at the headline and 0.2% at the core. Core inflation was boosted by shelter costs, which increased 0.3%. This was driven by rental prices, which experienced its biggest increase in more than four years (+0.4%). On a year-over-year basis, core consumer inflation was 2.0%, in line with the Federal Reserve’s target.
Alternative measures of inflation also illustrate that price rises remain contained, despite the unprecedented levels of liquidity that global central banks have pumped into financial markets. The Cleveland Fed’s median and trimmed-mean CPI indices – which are designed to account for potential distortions caused by the “unusually large weight given to Owners’ Equivalent Rent” – also show fairly muted results. Over the past year, median CPI has increased 2.2% and the trimmed mean CPI has risen 1.9%. The median CPI actually softened slightly in October after running for several months at a 2.3% rate.
A number of manufacturing indicators released last week appeared to be negatively influenced by Hurricane Sandy.
The Empire State Manufacturing index improved marginally, from -6.16 to -5.22 in October. Overall, the report was mixed, as positive news in terms of shipments and new orders was offset by a big drop in the employment index. The latter reading may have been influenced by the weather, although there was a bifurcation in terms of the storm’s impact. One-fifth of survey respondents from the upstate New York area reported production interruptions because of the storm, while 100% of downstate businesses experienced a reduction in business activity of one day or more.
The Philadelphia Fed index saw a steep contraction, however, falling from 5.7 to -10.7. This was in stark contrast to expectations of a 4.5 reading. Declines were concentrated in the important new orders and shipments components, while employment indicators also remained in contractionary territory. Similar to the New York report, roughly 75% of respondents indicated their businesses experienced at least one day of reduced business activity because of the storm.
Industrial production declined 0.4% in October, below the 0.2% growth anticipated. Hurricane Sandy affected these results too, estimated at a 1.0% headwind for the month, according to Barclays Research. The bulk of this occurred in the manufacturing component, which contracted 0.9%.
Even when excluding the storm effects, it is clear the US manufacturing sector is no longer growing at the robust pace witnessed earlier in the recovery.
The pattern of positive surprises in economic data has continued in recent weeks, although the acceleration seen during the past 3 months has abated. The Citigroup Economic Surprise Index (CESI) reached a near-term peak of 60.8 on Monday, before dropping off to 47.5 on Friday. Since the index moved into the low 40’s in October, the CESI has flat lined somewhat as economist expectations realigned with economic data.
Some of last week’s drop in the CESI was due to a big spike in initial jobless claims. In the week ending November 10, initial claims came in at 439,000. This is the first reading above 400,000 since October 2011, and represented a 78,000 uptick from the prior week. This report did not escape the hurricane’s effects either, as a number of the hardest hit areas saw big jumps in the number seeking unemployment benefits. A mean reversion in the coming weeks is likely to occur in this series as normalization occurs.
Based on some of the early data, it appears Hurricane Sandy will have a discernible impact on fourth quarter GDP. Barclays Research predicts a 0.2-0.3% headwind to the figure as a result of disruptions in economic activity and infrastructure damage. However, much of this is likely to be made up (and possibly more) as rebuilding efforts boost industrial production, construction spending, and retail sales in the quarters ahead.
COMPANIES GRAPPLE WITH PRESSURE FROM ALL SIDEs
As we move closer to closing the books on another earnings cycle, it is time to look back at the hits and misses for the quarter. Unfortunately, this quarter brought more misses than investors have seen in quite some time, despite a greatly reduced bar. The outlook also leaves something to be desired, with companies cutting forward guidance and analysts ratcheting down estimates for the next two quarters.
According to FactSet, 468 of 500 companies in the S&P 500 Index reported earnings so far. Of those 468 companies, 71% reported earnings above average estimates, while only 40% beat from a revenue standpoint.
One moderately “bright” spot was the earnings growth rate relative to expectations. Analysts revised down earnings expectations on a regular basis over the past several months. By the start of the quarter, analysts were anticipating a 3.1% slowdown in earnings growth. Right now, aggregate earnings are down by 0.2%. This is on track to be the first negative earnings quarter after 11 positive quarters, but nonetheless, slightly better than anticipated.
The bad news could be yet to come. There were 100 companies that issued guidance for the fourth quarter and 72 guided below average earnings. Analysts are joining the party, reducing fourth quarter growth estimates from 9.3% to 5.0%
At the sector level, more than 80% of companies in Health Care reported earnings above estimates, with Consumer Staples closely behind. On the laggard side, Telecom Services and Materials saw roughly 50% of companies beating estimates.
It is important to recognize that financial companies also played an outsized role in propping up the S&P 500 growth rate for the quarter. Financials reported a 16.1% earnings growth rate, easily beating the September 30 estimate of 9.1%. Excluding the impact of financials, the index would have seen earnings drop more than 3%.
Bank of America/Merrill Lynch documented one interesting phenomenon that will not surprise anyone watching the news recently. Specifically, the number of companies mentioning “fiscal cliff” during earnings discussions jumped to nearly 25% from below 10% the quarter prior. That superseded concerns about previous hot button issues such as Spain and Italy.
Source: FT Alphaville
Recognizing the uncertain economic climate both home and abroad, many companies undertook cost-cutting measures during or after the quarter. So far, this has included the closure of production facilities, elimination of jobs, and cutting dividend payouts in some instances.
With uncertainty continuing to impact global economic growth, companies are doing the only thing they can to protect profitability – become more defensive. Once issues such as the fiscal cliff are resolved and greater visibility into 2013 growth becomes available, companies may once again pivot towards a more aggressive posture. For now, though, expect more of the same with companies reducing workforces and feeling margin compression from all sides.
the week ahead
There are a few important indicators on tap for the holiday shortened week. On Monday, existing home sales and the housing market index are released, followed by housing starts on Tuesday. Consumer sentiment, which recently reached a post-recession high, is due out on Wednesday.
Equity and bond markets are closed Thursday for Thanksgiving, and re-open for limited trading on Friday.
The central banks of Japan, Turkey, South Africa, and Colombia meet this week. Turkey is expected to cut its target interest rate.
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