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Thus far, the positive earnings news out of individual companies have dwarfed the mostly positive macroeconomic data released this week. The outstanding news from companies was very broad-based, ranging from consumer goods leader Apple to luxury goods retailer Coach  to manufacturing giant Illinois Tool Works.  Many corporations produced the trifecta of improved sales, stunning margins, and higher forecasts for the year ahead. These are indications that the severe expenditure and labor cutbacks of 2008-09 are adding significantly to bottom line growth and that B2B sales are improving, as well as higher-end sales. 

The macroeconomic data for the week wasn’t so bad either, as both new and existing home sales were up from month to month, exceeding most expectations.  Initial Unemployment Claims were finally down again after a couple of weeks of moving the wrong way. Excluding aircraft, durable goods orders were also surprisingly good.  Analysts would like to see strong order strength as the orders will move into production and shipments in the months ahead. Strong orders, growing production and slim inventories may lead to more employment. That will mean even more dollars in consumer pockets, leading to stronger consumer sales. 

Many analysts continue to believe the economic momentum will be hard to stop. Fear that modestly higher interest rates or an expiring housing credit is going to stop this economy in its tracks is misplaced. Just as with the expiration of the Cash for Clunkers program, there could be a couple of soft months after the homebuyers’ credit expires or rates rise, but ultimately sales may stabilize at levels higher than before. The underlying strength in corporate earnings and consumer spending is just too hard to deny.

Key Trends
Although every industry is in a slightly different stage of recovery, there a few common themes out of this quarter’s earnings results:

• Sales Growth at Last
• Huge Operating Leverage/Margin Improvement
• Strong Non-U.S. Markets, Especially Asia/Brazil
• Building Momentum Each Month

First, most companies are returning to a meaningful level of sales growth. During several of the past quarters, we had to settle for sales declining at slower and slower rates.

While 5%-10% growth seemed to be the norm for a lot of industrial concerns, Apple posted sales growth of 50%. A lot of the improvement in corporate revenues went straight to the bottom line, too. In the case of Apple, revenues were up 50% but earnings were up a more stunning 90%.

In the industrial world, margins at manufacturing giant Illinois Tool Works bounced back to the 13% range from the low single digits a year ago and a typical peak margin of 17% or so.

A lot of the best growth was outside the U.S., with even Apple making note of strong sales in Asia. Likewise, manufacturer Eaton saw its best sales results in Asia and Brazil, while management noted U.S. growth was finally beginning to accelerate.

Several companies also noted that sales momentum was building during each month of the quarter, which may bode well for sales results in the months ahead. For example, housing analysts noted that ITW reported sales growth of just 4% in January. ITW sales jumped 6% in February, and a very impressive 13% in March.

Although far less widespread, there were a few other things in this quarter worth mentioning:

1.  Hiring Resumes, Especially at Software Firms while  Inventory Shortages Constraining Sales
In terms of hiring this quarter we heard several software companies including Oracle  and Google were ramping up hiring.  A recent Wall Street Journal article even noted a bidding war for some mid-level developers. As earnings continue to pick up, many analysts believe the hiring spigots will open in more industries during the second quarter.  It is also interesting that we have already begun to hear more about parts shortages. Seagate, a manufacturer of computer disk drives, complained that they could have easily shipped more disk drives if inventories had been higher.  Flash memory (used in cameras, jump drives, and as replacement for hard drives) is also said to be in very short supply. Market analysts who are indicating there is a ton of excess capacity in our economy need to take a little closer look at individual categories.

2.  Real Estate Shows Some Signs of Life for Now
Both new and existing home sales were strong in the month of March, exceeding general expectations.  Existing home sales were up 6.8% from February and almost 16% from a year ago at 5.3 million units. The Homebuyer Tax Credit is helping, but it isn’t helping nearly as much as when sales jumped to well over 6 million units in October and November 2009. Because the bounce hasn’t been as big from this round of credits, most analysts anticipate that the post-credit decline may also be a bit milder, and 4.5-5.5 million units might prove to be the new normal for existing home sales. Many believe that employment growth, incomes, and overall confidence as well as population growth will all offset the expiration of the housing credit after a couple of months of lag time.

New home sales in March jumped an even more stunning 27% to 411,000 versus expectations of just 320,000 units. That sequential growth was higher only in 1963 when new home sales grew 31%. Since new home sales must be signed by April to get the credit, and new home sales are recognized when contracts are signed, we may see one more good month before they dip again. Since existing home sales are recognized in the official statistic at closing (which typically happens two or three months after contract signing), existing home sales may peak in June, two months later than new home sales. While analysts are glad to see the good numbers (and they are likely to have a positive effect on GDP), one shouldn’t get too excited now and then depressed again in July.

3.  Real GDP Growth Likely to Surprise on the Upside Next Week
Next week’s GDP growth rate may come in at 4% or more.  Although the consensus estimates for the quarter have moved up from 3% to 3.5% over the last few weeks of positive economic news, those estimates could prove wide of the mark.

If so, stocks may react well to the news while bonds may take another hit with another surprisingly strong quarter of growth.  Within the GDP forecast, the consumer expenditures for the quarter could be in the 3.5%-4.0% range, which would make it by far the best quarter since the recovery began last June. It would represent a sharp improvement from the more meager 1.6% growth rate reported for the December quarter.

This quarter may show that the inventory adjustment will be a smaller, but still significant, contributor to GDP (an additional 1%-2% versus close to 4% in December). Exports and business spending will also kick in a little help this quarter, while construction, especially nonresidential, could hurt overall results along with stronger imports.

Next week will also bring consumer income data as well as expenditures for the month of March. Incomes may still be a bit stagnant while expenditures may be up 0.6% or more. Analysts reportedly base their optimism on retail sales that were up 1.6% in March with minimal inflation. The income category may gain strength in the months ahead as the economy adds 100,000-200,000 jobs.

All in, it would be hard to suggest that the economy is not improving.  If there is a scare ahead, it has moved from Wall Street to Pennsylvania Avenue.  For now however, there may be blue skies above stock trading floors, with pressure continuing, albeit moderate pressure, on bond prices.

Content Provided by:

Darold C. Brooks, CFP
Southport Capital, Inc
Registered Investment Advisors.
770.578.1225

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