Over the last few days, we've gotten more signs the domestic economy is...oh, how do we put it..."eh," leaving Hawkins humming, "You've lost that lovin' feelin..." While there were positive aspects to both the March retail sales and industrial production numbers, like the former being up after several weak readings and the latter seeing some manufacturing strength, the inner Debbie Downer in us feels the need to point out that once again, these economic indicators missed Wall Street expectations, continuing what is looking like an impressive negative streak.
The 0.9% rise in retail sales was below expectations for a 1.1% increase and, frustratingly, didn't do much to reverse the 2.1% decline over the preceding three months. Digging a bit deeper, about 80% of this month's increase was due to sales of motor vehicle and parts (up 2.7%) and building materials and garden equipment (up 2.1%), both of which are intensely weather-sensitive.
Excluding the automotive sector, manufacturing declined 0.1% in March. Good if you are Ford (F), Fiat Chrysler (FCAU), General Motors (GM) or Volkswagen (VLKAY) shareholders, but not so much if you're an industrial company, seeing as how over the entire first quarter, industrial production dropped 1.0%.
Now we could stop there, but as long as we are channeling Debbie Downer, we could lump in the drop in the April Empire Manufacturing Report and the slowing growth in China during the March quarter. This morning, China's National Bureau of Statistics reported that the economy grew 7.0% year over year in the March quarter, down from 7.3% in the December quarter, and just over 5% on an annualized pace, while industrial output was a meager 5.6%, the softest since November 2008 and below consensus estimates of 7%. In our view, this is hardly new news given the string of weaker PMI data points over the last few months. We do agree that this ups the ante for China to join the two dozen other countries that have eased since the start of the year.
Given the move in iShares FTSE/Xinhua China 25 Index (FXI), it would seem that many are banking on China loosening up monetary policy. But as we've seen in the past, expectations do not always measure up to reality, or in this case the level of easing that may occur. Over the last month, FXI shares have climbed nearly 23%, far more than the 2.6% return in the S&P 500, and our advice would be for Real Money subscribers holding FXI shares be prudent and take some gains.
What's our take on all this? It's going to make for an interesting reporting season. In the crosshairs of all of the above is General Electric (GE) and Honeywell (HON), both of which are scheduled to issue quarterly results on Friday. It looks to us that many companies are taking this first quarter to get any bad news out of the way with a 6-to-1 negative/positive earnings pre-announcement ratio, setting expectations so low that they just need to barely meet their low-bar targets to have stock prices jump.
Chip maker Intel (INTC) just pulled this trick off, jumping over 4%, after announcing a forecast for flat revenue for the year thanks to weak demand for desktop computers and reduced inventories for computer and parts suppliers! Digging a bit deeper into Intel's numbers, we see that while sales in Q1 2015 were about the same as Q1 2014, gross margin narrowed to 60.5% from 65.4%. We struggle to see why the market got excited about flat revenue coupled with rising costs. Digging even further, we see that the company also reduced its research and development budget by nearly 13%, which sounds like an odd call for a technology-based company that is already struggling to grow sales. That's like cutting back on one's daily showers to just once a week after bemoaning one's lack of dating prospects!
Always keeping an eye on ripple effects. Intel's cut to capital spending guidance, the midpoint of which now stands at $8.7 billion, down $1.3 billion from the prior outlook, will weigh on Applied Materials (AMAT), Lam Research (LRCX) and other semiconductor capital equipment companies. More could be had on semiconductor capital spending tomorrow when Taiwan Semiconductor (TSM) reports its quarterly results.
On the upside, shares of JPMorgan Chase (JPM) closed at record 15-year highs after having beaten forecasts, with both higher trading revenue and profits. Given just how much of the economy the company touches, this is a positive sign. Wells Fargo (WFM) also rose on news that its revenue climbed 3%, with deposits and mortgage applications increasing but net-interest margins coming in below expectations.
On the downside, however, all 10 components of the National Federation of Independent Business' (NFIB) small business optimism index fell in March. The report states that, "Small business owners are not encouraged to expand their businesses when consumer spending is down, U.S. trading partners are weakening and the government continues to try and micromanage the private sector with red tape and regulations." It is tough to get the economy humming along when small businesses aren't in an expansionary mood.
So far, earnings announcements haven't shocked Wall Street, but we still believe that upside potential vs. downside risks look more attractive across the Atlantic. European equities are enjoying support from a weaker currency, lower interest rates (the German 10-year is closing in on zero!), lower oil prices, strong earnings ex-energy, the joys of quantitative easing vs. talk of rate increases in the U.S., and positive fund flows as portfolio managers shift away from underweighting the region.
Back home, we still think surprises to the downside this earnings season are more likely than not, which given current valuations, makes for material downside risks. Investors looking to increase their exposure to Europe can hedge against the impact of a likely rising dollar relative to the euro through WisdomTree Europe Hedge Equity Fund ETF (HEDJ) or iShares Currency Hedge MSCI EAFE ETF (HEFA).