The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Good Evening: And so it continues. The pattern of an early drop in stock prices, followed by a late day rally held true to form again today. This trend has become so entrenched in recent weeks that, according to CF Global’s Philip Grant (who writes a fine market recap of his own), “the S&P 500 has now gone twenty one consecutive trading days (dating back to July 7) without sustaining a loss of 0.5% or greater.” Despite some choppy economic data and an earnings miss by Dow stalwart, Procter & Gamble, all it took was a hint of improvement in the July charge off data from American Express to bring the major averages back from their early declines. Since the transaction volumes at AXP are still falling at a double digit rate, what struck me about today’s news flow is that PG, AXP, and the ISM services survey all portray a less healthy U.S. consumer than Mr. Market would have us believe.

When Procter and Gamble announced an 18% decline in its Q4 earnings this morning, U.S. stocks were bound to take an early hit. Sales fell across the board for PG, a company that is supposed to be in the “recession-proof” category. The pre-opening economic data didn’t help, either. The employment data (Challenger Job Cut Report, ADP payroll estimate) were both on the weak side, setting up a potentially wider range of outcomes for Friday’s unemployment figures. The first dip in equities was bought once trading commenced, but that buying dissolved as soon as the ISM services survey results were posted. Against consensus estimates for a rise to 48.2, this survey of non manufacturing businesses inconveniently fell to 46.4 in June. Since, like many other data points of late, this piece of data had been getting less bad (remember, 50 is zero growth), a relapse for the worse was unwelcome. Factory orders were on the high side of expectations, but the major averages wasted little time in dropping 1% to 1.5% in the wake of the ISM release.

After bouncing around in the lower half of the day’s range for the next few hours, stocks recouped all their losses after American Express told analysts that AXP’s charge off rate in July would likely fall to 9.2% in July, versus 9.9% in June. The green shoots crowd seized upon this wonderful piece of news and bid up the company’s shares (AXP rose 5.75%). Not satisfied, market participants then presumed that all financial companies would soon see declining credit losses and bid up the whole financial sector (the BKX finished + 3.5%). Buyers even latched onto the lowly AIG and sent it zooming ahead to the tune of almost 63% today. First, the shorts trying to cover sent the name higher; then, rally established, the trend-seeking Quants bought more.

After trading above the unchanged mark for a short spell, the averages fell back a bit into the close. Wednesday’s losses ranged from 0.3% for the S&P to 0.9% for the Dow Transports. Treasurys had been up this morning, despite a larger than expected refunding schedule announced for next week, but the equity rally acted like gravity on government securities as the day progressed. Two year notes were flat, but yields rose as much as 8 bps on the long end of the curve. The dollar was a bit weaker and commodities were a bit firmer. The CRB index finished with a gain of 0.5%.

Just last year, Procter and Gamble was raising prices on many of its household products to combat the rising costs of raw material inputs. Presto! Margins were restored. But the consumer products giant will now have to rethink its strategy due to falling volumes (see below). Consumers are cutting back, even on items in PG’s sweet spot that are considered non-discretionary. Procter’s troubles aren’t behind it, either, since the company said it expects the weakness to continue for the rest of the year.

This picture of a consumer who is skimping on the basics was also confirmed by American Express today, it’s cheerful credit news notwithstanding. According to Reuters, CFO, Daniel Henry, said billed business declined 13 percent in July, compared to a 14 percent fall in June and a 17 percent drop in May. Double digit declines in a company’s main business are not good, even if the trend has a gentler negative slope. Consumers are charging less on their credit cards, including items like Crest, Tide, and quadruple-bladed Gillette razors. With today’s ISM non manufacturing survey saying that the largest sector of the U.S. economy (services) is still under pressure, it’s hard to see how PG and AXP will see better days any time soon.

If these behemoths are struggling, then what do their woes imply for the rest of the economy — or the stock market? Now that Q2 earnings season is largely in the books, the basic theme has been one of falling revenues but better than expected profits. The difference has been cost cutting (layoffs, less travel, etc.), but one company’s cost cuts hit the revenue line of other businesses. In the final article you see below, Charles Rotblut, CFA. and Senior Market Analyst & Editor at Zacks, argues this trend cannot persist.

Zacks lives and breathes earnings estimates, and Mr. Rotblut notes that earnings estimates aren’t rising as much as they should be if a recovery were truly taking hold. Even using the highest estimates for the combined earnings of the S&P 500 ($60.00), an index level of 1000 puts the P/E at a non bargain level of 16.67. These are only operating estimates (the “as reported” figures are far worse), so I think Mr. Rotblut’s caution is justified. The economy may be getting less worse, but the 50% leap in the S&P since March implies an economy that is getting better. All the more reason to pay close attention to Friday’s employment data. More than the number of the newly jobless, and more than even the unemployment rate, I’ll be watching to see if hours worked and average hourly earnings can tick higher. These last two series are the stuff of real incomes, the very stuff, in fact, that consumers need in order to pay for a load of P&G items with their American Express cards.

– Jack McHugh

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