We've been warning for months that the "weakness-due-to-weather" explanation for the first quarter's weak economy has become Wall Street's version of the "dog-ate-my-homework" excuse. As June economic figures roll in, hopes for a significantly stronger second quarter are going the way of Greek sovereignty and rapidly disappearing.
On Tuesday, markets got disappointing June retail sales figures, followed by a painful National Federation of Independent Business report on small-business optimism.
Here some bad signs that we see:
U.S. retail sales' three-month moving average is at a level not seen before outside of recessions. While May retail sales were up from April levels, they were revised downward to +1% from +1.2% -- and there remains an overall downtrend that's clear in the chart below, with June sales 0.28% below May.
Business inventories are also rising, which is yet another worrisome trend. If consumers don't buy, retailers don't reorder. That leads to a build-up in wholesaler inventory, which means wholesalers don't reorder from the manufacturers. Well, it turns out that that's exactly what the chart shows have been happening.
The NFIB's Small Business Optimism Index continued to decline in June, falling another 4.2 points to 94.1 -- well below the 42-year average. Nine of the index's 10 components declined over the month, making this a rather broad-based problem.
This morning, we learned that U.S. capacity utilization for total industry rose ever so slightly in June after being down six months in a row as of May.
This index represents the percentage of resources used by corporations and factories to produce goods in manufacturing, mining, and electric and gas utilities for all facilities located in the United States (excluding territories).
Capacity utilization has only fallen six months in a row 10 times since data collection began in 1967. Every single time that's happened before, the economy was in recession. In fact, the economy has never been in a recession when the metric didn't fall for at least six consecutive months.
This month's uptick to 78.4 from 78.2 isn't exactly a screaming comeback, and is still below last year's 79.2 for June. So, we're far from out of the woods just yet.
Don't be fooled by the modest uptick, either. If we dig below the headline, we find that manufacturing capacity utilization ticked down again month over month, as did that of mining.
The sole reason for the better headline? Warmer weather that had utilities firing up so we could power our air conditioning. Perhaps there's more than a seasonal bump to be had with the Utilities Select Sector SPDR (XLU).
We also learned today that industrial production finally came in above expectations for June after having come in at or below expectations six months in a row (with a rather concerning downward trend since January). June was also the first positive month since February's barely-in-the-green +0.1%.
As with capacity utilization, manufacturing production once again underwhelmed -- coming in unchanged vs. 0.1% expectations.
Another great metric for economic activity comes from the transports. While we've all seen the beating that transport stocks have been taking recently, what about the amount of stuff that's actually been moved around so far in 2015?
Well, that's not exactly looking inspirational. Not only is 2015 rail traffic materially lower overall than 2014's, but May saw a sizeable decline both relative to April and to May 2014.
We did see a move up in June from May, but June 2015 is still below both April 2015 and June 2014. It's tough to argue that the economy is improving when the metric for moving stuff around continuing to show weakness relative to last year.
While the headlines recently trumpeted the falling unemployment rate, we're a lot more concerned that the labor force participation rate has continued to fall, down to 62.6% for June. That's a level not seen since the 1970s.
Many claim this is due to an aging population -- which has some merit, but doesn't explain the entire decline. Either way, the fewer people working, the weaker the economy.
With fewer people working and a stubbornly sluggish economy, median household income is still well below where it was over 15 years ago, but at least it's been trending up and is now around where it was at the Great Recession's end.
This likely means continued tailwinds for what we call "Cash-Strapped Consumer Companies" like Target (TGT), Costco (COST) and Ross Stores (ROST). But retailer like Gap (GPS) that just can't seem to get the value-to-price ratio at a compelling place for the cash-strapped consumer will continue to have little margin for error. We continue to favor Under Armour (UA) as it looks to have nailed it on both quality and price for struggling consumers.
For those that are working, they have a heavier burden to shoulder than in generations past. We now have 14% of the population on food stamps, 49.7% receiving some sort of government benefit and the American Dream of owning a home has become that much more unattainable with today's median home price 10.1x median income versus 6.1x in 2000.
This is a definite headwind for home builders like KB Homes (KBH) and Toll Brothers (TOL). After all, more people are dropping out of the workforce, retirees are look to downsize from existing homes and young workers are postponing buying places thanks to bleaker job prospects and the heaviest student-loan debt ever.
Investor optimism appears to be quite high given how markets have been shrugging off the Greek turmoil, but the Dow Jones Industrial Average closed the first quarter down -0.26% for the year and second quarter down -0.88% from the there. The last time the Dow fell for two quarters in a row was in 2007, and the time before that was in 2000. We all know how those periods turned out.
If you think the weakness is likely to continue, take a look at the ProShares UltraShort Industrials ETF (SIJ).
The bottom line
All this has the two of us particularly focused as we head into earning seasons. The discrepancy between top-line revenue growth that's been meager and bottom-line EPS growth that's been more robust primarily thanks to financial engineering (like share buybacks) has to come to a head at some point. This earning season might just be the time.