The Stock Market

Our Fundamental Stock Market Indicator (FSMI) remains bullish. However, it did slip 0.2% during the week of March 17 after rising eight consecutive weeks by 15.9%. The next few weeks should be interesting for the three components of the FSMI:

(1) We’ll see if initial unemployment claims continues to fall. If it moves higher, then the weather-did-it crowd will jump for joy.

(2) The CRB raw industrials spot price index has been flattened in recent days on concerns that China’s economy is slowing and Europe is falling deeper into recession following the release of weak “flash” March PMIs last week. There will be another batch of global PMIs coming out for March early next week.

(3) The Weekly Consumer Comfort Index has been surprisingly buoyant in recent weeks despite rising gasoline prices.

Despite the surge in gasoline prices, consumer-related stocks have gone vertical this year. In the S&P 500, both Consumer Discretionary and Consumer Staples are trading at new record highs and at valuation premiums to the market. The Consumer Discretionary Retailing industry stock price index is up 20.1% ytd to a record high, and trading at about 18 times forward earnings.

BULLET POINTS FROM TODAY’S MORNING BRIEFING: (1) Next stop after 1400? (2) Will US lift global growth, or get dragged down? (3) The “weakness dividend” puts a lid on commodity prices. (4) Calming oil market’s jitters. (5) Go Home vs. Go Global. (6) Energy and Materials stocks diverging with commodity prices this year. (7) S&P 500 revenues still looking up. (8) Are durable goods orders durable? (9) Housing is crawling out of the cellar. (10) Do Industrials have more upside? (More for subscribers.)

Bernanke's Speech

Monday’s 1.6% increase followed a speech delivered in the morning by Fed Chairman Ben Bernanke before the National Association for Business Economics. It was a relatively technical discussion of recent developments in the labor market. The Fed Chairman concluded that while it is improving, there’s room for improvement. So Fed policy will remain accommodative, which was the main point I made in Monday’s Morning Briefing just before Bernanke confirmed my conclusion in his latest speech.

In his own words: “A wide range of indicators suggests that the job market has been improving, which is a welcome development indeed. Still, conditions remain far from normal, as shown, for example, by the high level of long-term unemployment and the fact that jobs and hours worked remain well below pre-crisis peaks, even without adjusting for growth in the labor force. Moreover, we cannot yet be sure that the recent pace of improvement in the labor market will be sustained.”

That is essentially the same message that FRBNY President Bill Dudley delivered in his speech on March 19 and that Professor Bernanke mentioned in passing during his GWU lecture on March 20. As I noted yesterday morning, the most important message for investors is that the Fed is in no rush to raise interest rates no matter how well the economy seems to be performing.

While the market was a bit wobbly last week, stock investors concluded on Monday that Mr. Bernanke is determined to lead them to Nirvana, where interest rates remain near zero even if the economy is growing robustly.

While there is some debate on whether the Fed Chairman implied in his speech that another round of quantitative easing is coming, I don’t think there was any ambiguity about his intention to keep the federal funds rate near zero even if the economy continues to improve. Here is what he said: “To the extent that this reversal has been completed, further significant improvements in the unemployment rate will likely require a more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies. I also discussed long-term unemployment today, arguing that cyclical rather than structural factors are likely the primary source of its substantial increase during the recession. If this assessment is correct, then accommodative policies to support the economic recovery will help address this problem as well.”

The percentage of respondents agreeing that “jobs are hard to get” in the March Consumer Confidence survey rose to 41.0% from 38.6% in February. The jobs-hard-to-get response is highly correlated with the unemployment rate and suggests that the latter might not have continued to decline in March. We now have four regional business surveys for March covering the Fed districts around Dallas, New York City, Philadelphia, and Richmond. The average of the employment components of these four was little changed at last month’s most recent cyclical high.

BULLET POINTS FROM TODAY’S MORNING BRIEFING: (1) Sun-Tzu tells bulls to stay close to bears. (2) Blinder’s fiscal cliff. (3) Simpson-Bowles lite? (4) How lame will the lame ducks be? (5) Lots of popular loopholes. (6) Ryan’s Express on slow track unless Supremes kill ObamaCare. (7) When will stocks discount the cliff scenario? (8) Consumer stocks climbing every mountain. (9) Tech stocks still cheap. (10) The employment cliffhanger. (More for subscribers.)

The Bernanke Lectures



   

Back to school. In case you need a refresher course in central banking, Fed Chairman Ben Bernanke is providing a series of four free lectures on the Fed’s website. He delivered two of them last week at the George Washington University School of Business on Tuesday, March 20 and Thursday, March 22. There will be two more this week on Tuesday, March 27 and Thursday, March 29. The most important message for investors in the first lecture is that the Fed Chairman is in no rush to raise interest rates no matter how well the economy seems to be performing.

It’s great that the Fed Chairman has some free time to educate us. Of course, the point of this exercise is to let us know what an outstanding job the Fed has done in averting a financial meltdown during Bernanke’s watch. According to him, the Fed has done so well by learning from the mistakes made by monetary policymakers during the 1930s. No one has studied this subject more than he has. However, his intense focus on the role of monetary policy in causing and prolonging the Great Depression seems to have blinded him to other causes, such as the Smoot-Hawley Tariff, which isn’t mentioned even once in his Essays on the Great Depression (2000) or in his first lecture.

On November 8, 2002, when he was a Fed Governor, Ben Bernanke famously concluded the speech he gave at Milton Friedman’s 90th birthday as follows: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” The Great Depression was caused by monetary policy mistakes, and the Fed won’t make those mistakes again.

In his lecture, Mr. Bernanke blamed the Fed for causing the 1929 stock market crash by raising interest rates rather than focusing on “bank lending, on financial regulation, and on the functioning of the exchanges.” I would argue that the Fed set the stage for the latest financial crisis by raising interest rates too slowly in the years before the crisis. Presumably that was meant to avoid repeating the bad economic “side effects” that rising rates had in the 1930s, according to the first lecture. The lesson learned during the 1930s made the Fed too cautious this time. Worse, in the years preceding the latest financial crisis, the Fed failed to regulate the excesses in the over-the-counter exchanges for credit derivatives. That led to the collapse of securitization, which triggered a credit crunch that nearly caused another Great Depression.

In his lecture, the Fed Chairman observed that the Great Depression was actually two recessions with a severe downturn from 1929-1933 and another one in 1937-1938. In between the two, there was a good recovery. While he concedes that the cause of the second downturn is controversial, he believes it was a “premature tightening of monetary and fiscal policy.” He concluded: “I think if you accept that traditional interpretation…you need to be attentive to where the economy is, and not move too quickly to reverse the policies that are helping the recovery.”

Today’s Morning Briefing Bullet Points: (1) Paradise found. (2) An impressive 6-month bull market within an impressive 3-year bull market. (3) Bernanke bad-mouths good employment indicators. Stocks cheer. (4) Leaders are Consumer Discretionary, Financials, & IT. (5) Revenue estimates continue to rise. (6) P/E-led rally has more upside. (7) PEG ratios find value in Consumer Discretionary, Industrials, and IT. Overvalued are Consumer Staples, Health Care, Telecom, and Utilities. (8) Housing recovery stalled in Feb. and Mar. (9) Another happy employment indicator in Texas. (10) Still some oomph in Germany’s Ifo. (More for subscribers.)

Global Industrial Production

Despite all the natural and man-made disasters of 2011, global industrial production rose to a record high during the final month of last year based on an index compiled by the OECD for its 30 members of “advanced” economies and the six largest emerging economies. That index now exceeds the previous cyclical high during January 2008 by 3.8%. On the other hand, the index for just the 30 members was flat most of last year and remains 5.5% below its January 2008 cyclical (and record) peak. The resilience of the global economy in the face of the huge hit to Japanese manufacturing caused by the earthquake in March and the financial crisis in Europe is impressive.

Among the OECD economies, weakness in European production indexes has been offset by strength in the US. The Euro Zone 17 index of industrial production is down 3.5% over the past five months through January. Over the same period through January, the US manufacturing output index is up 3.4%. The latter did slow to a gain of 0.3% during February following 1.1% during January, which was revised upwards from 0.7%. Over the past three months through February, US manufacturing rose at an annualized rate of 9.6%, based on its three-month average.

TODAY’S MORNING BRIEFING BULLET POINTS: (1) Professor Bernanke explains it all. (2) Lessons learned from the 1930s. (3) Making new mistakes. (4) ZIRP no matter what. (5) Fizzle fears for a third year. (6) Two of the stool’s three legs are wobbling. (7) Spain’s pain. (8) A power struggle in China? (9) Spring break or spring wobble? (10) Underweighting Europe. (11) The global economy is slowing, not stalling. (More for subscribers.)

S&P 500 Revenues & Earnings

What do industry analysts know that we don’t know? They know more about the companies they follow than the rest of us who have chosen different career paths in the investment business. When I analyze the earnings, revenues, and profit margins of the S&P 500 along with its sectors and industries, I start by taking a peek at the data compiled weekly by Thomson Reuters on the analysts’ consensus for these variables. Then I try to reconcile my top-down “macro” model of these variables with the bottom-up “micro” expectations of the analysts.

What I am beginning to see recently is that industry analysts are turning more optimistic about the prospects for revenues this year and next year. They have also recently stopped lowering their earnings estimates for both years after having done so nearly every week since mid-2011.

Industry analysts have been nudging up their 2012 consensus estimate for S&P 500 revenues and raising their 2013 estimate since last fall, after lowering their expectations last summer. They expect that revenues will increase 4.5% this year and 5.5% next year. I track the time-weighted average of these annual estimates, which is a proxy for 52-week forward expected revenues. This measure bottomed at $910 during the week of September 24, 2009 and rose 22% to $1,110 during March 15 of this year. Along the way, there were soft patches during the second half of 2010 and last summer. But now, forward revenues for the S&P 500 is at a cyclical high and only 2.4% below the previous record high in mid-2008. (More for subscribers.)

Global Oil Supply & Demand

According to Oil Market Intelligence, global supply rose to a record high of 88.6mbd during February. OPEC’s output rose to a new record high of 37.2mbd. Non-OPEC oil production edged up to 51.4mbd, just shy of its record 52.1mbd during September 2010. While Iran’s output has dropped 0.3mbd over the past three months, Libya’s production has rebounded impressively from zero during last summer to 1.3mbd during February.

Among the non-OPEC producers, the ones in North America produced 9.0mbd during February, the highest in the history of the series going back to 1993. In Canada oil output is at a record 3.2mbd, and in the US it’s back at 5.8mbd, the highest since early 2002. The oil rig count in the US is soaring. It is up 57% over the past year to 1,317 during the week of March 16.

Meanwhile, global oil demand flattened during February at 89.1mbd. While oil demand rose to a record high for non-OECD countries, it has been trending downwards since last February among the OECD countries. In Western Europe, it dropped to the lowest since the summer of 1994. (More for subscribers.)

Global Inflation

Yesterday, for the first time in a very long time, I raised the prospect that inflation could be a problem that we need to monitor more closely. I started my career in the late 1970s when inflation rose to record highs in the US. Ever since the early 1980s, I’ve been a disinflationist. I was also a long-term bond bull as a result. When the 10-year Treasury yield was over 10%, I predicted “hat-sized bond yields.” Of course, they’ve fallen much lower in recent years.

Actually, there was an inflation problem early last year when rising food and fuel prices in the CPI reduced the purchasing power of consumers, which depressed consumer spending. However, core CPI inflation remained subdued, mostly because high unemployment kept a tight lid on wage inflation.

Energy prices are rising again this year in the CPI. They are up 21.8% during January and February at an annual rate. Food prices in the CPI are much more subdued, rising only 1.2%. Wage inflation was only 1.9% y/y during February based on average hourly earnings.

So where’s the inflation problem? As noted yesterday, it’s mostly in Asia on an anecdotal basis. More stories are popping up about rising labor costs in the region. This upward pressure is already showing up in US import prices on products coming from China. An index that tracks these prices is compiled by the Bureau of Labor Statistics. It fell 1.8% in 2009, and rose 0.8% in 2010 and 3.6% in 2011. Through February of this year, it edged down slightly to 3.3% y/y.

Meanwhile, despite the massive amounts of liquidity pumped into global financial markets by central banks, inflation remains mostly subdued around the world, though there is clearly an upward bias. Of course, the main reason they flooded the markets with liquidity was to avert deflation. They seem to be succeeding. The question is: Can they avert reflation?

Core CPI inflation among the 30 “advanced” economies in the OECD has risen from 1.1% y/y in the fall of 2010 to 2.0% during January of this year. That’s not a serious problem since it remains subdued and has been fluctuating in a flat range between a low of 1.1% and a high of 2.4% since 2004. (More for subscribers.)

 

US Treasury Bond Yields

The backup in the 10-year US Treasury bond yield since late February certainly reflects mounting confidence in the strength and sustainability of economic growth. The nominal yield rose to 2.31% on Friday despite the Fed’s commitment to continue its Maturity Extension Program (MEP), a.k.a. “Operation Twist.” Since MEP was introduced on September 21, 2011, the bond yield has traded mostly below 2.0%. Perversely, yields might be starting to untwist because inflationary expectations are rising. The spread between the 10-year nominal and TIPS yields shows that expected inflation has jumped from 1.86% when MEP was introduced to 2.4% on March 16.

Contributing to the backup in bond yields were better-than-expected February reports for employment on March 9 and retail sales on March 13. In addition, the statement released by the FOMC after the meeting on March 13 noted: “The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate.” There was no hint of any new rounds of quantitative easing or yield curve twisting.

In the February 7 Morning Briefing, I raised the following warning flag: “What if the economic indicators continue to be stronger than expected? What if employment gains are even stronger in coming months than they were in January and the unemployment rate falls below 8%? The consensus interest rate outlook/forecast/assumption (or whatever it is) of the members of the FOMC implied that they expect that the economy will remain weak through the end of 2014. That’s a very gutsy forecast for the next three years, and already seems like it could be ridiculously wrong. If so, will the members of the FOMC raise their interest rate projection during their next quarterly survey? If they do, there is a good chance that bond yields will soar on that news. If they don’t do so, their credibility and objectivity will be seriously compromised.”

A backup in bond yields could be quite a jolt for retail investors. Last year, their net inflows including reinvested dividends into bond mutual funds totaled $214.0 billion, while there was a net outflow of $67.5 billion from equity mutual funds. Inflows into bond funds remained strong through last week. Corporations have issued roughly $400 billion in bonds since the beginning of the year.

On March 8, I wrote: “In my opinion, the Fed should let Operation Twist terminate as scheduled and cease and desist from any additional easing. More likely is that Operation Twist will be extended through the second half of the year if bond yields start moving higher. The Fed’s excuse for doing so is likely to be that the housing recovery remains fragile, so it is important to keep mortgage rates low.” There is already some chatter about the FOMC implementing a program of sterilized bond purchases at either the April 24-25 or June 19-20 meeting of the committee. Extending MEP may not make sense since the Fed is projected to have only $200 billion of short-term Treasuries by mid-year. (More for subscribers.)

Fundamental Stock Market Indicator

The S&P 500 closely tracks my Fundamental Stock Market Indicator (FSMI). The FSMI is a very good coincident indicator that can confirm or raise doubts about swings in the market. It advanced for the seventh straight week, climbing 1.0% during the first week of March and 14.7% over the seven-week period. It’s now only 0.1% shy of its cyclical high posted in February 2011.

The FSMI is the average of our Boom-Bust Barometer (BBB) and the Weekly Consumer Comfort Index (WCCI). Here’s how they performed during the week of March 3:

(1) The BBB increased for the sixteenth time in 18 weeks, up 0.1% w/w and 16.4% over the 18-week period. It’s now within 3.5% of its record high posted last March. Jobless claims--a component of our BBB--edged up to 355,000, based on 4-wa, after falling to 354,750 the prior week (which was the lowest reading since March 2008). The CRB raw industrials spot price index, another component, has been climbing again in 2012, though is stalled at recent highs.

(2) Bloomberg’s WCCI jumped 3.4% after slipping 0.6% the prior week (which was only the second decline this year). The index is at its highest reading since April 2008, moving out of its multi-year flat trend. (More for subscribers.)

US Federal Tax Receipts

There was some puzzling and disappointing news on tax receipts in yesterday’s Monthly Treasury Statement of Receipts and Outlays for February. Until recently, there was plenty of good news in individual income tax receipts as the 12-month sum rebounded from a low of $847 billion during January 2010 to $1,113 billion during November 2011. It has stalled since then as the sum edged lower to $1,094 billion during February. That certainly doesn’t jibe with the significant improvement in employment in recent months that I discussed yesterday.

On the other hand, the 12-month sum of total payroll tax receipts turned up in December for the first time since the fall of 2008, edging up to $815 billion in February. Debbie and I believe that the recent strength in payroll employment is sustainable and should soon be confirmed not only by payroll tax receipts but also by individual income tax revenues, which tend to be a lagging economic indicator.

Of course, a more troubling issue than the recent slowing in individual tax receipts is that total tax receipts covered just 65% of total outlays over the past 12 months through February. That’s up from a record low of 58% during February 2010. But, come on, that’s really pathetic. This is exactly the sort of fiscal recklessness that is now forcing Greece and other European social welfare states to adopt painful fiscal austerity measures, which more accurately should be called “fiscal sanity measures.”

In a 3/5 speech, Dallas Fed chief Richard Fisher compared the fiscal recklessness in the US to the discipline in Mexico as follows: “I was in Mexico last week. Mexico has many problems, not the least of which is declining oil production, low school graduation rates and drug-induced violence….Now hold on to your seats: Mexico actually has a federal budget! We haven’t had one for almost three years.

“Furthermore, the Mexican Congress has imposed a balanced-budget rule and the discipline to go with it, so that even with the deviation from balance allowed under emergencies, Mexico ran a budget deficit of only 2.5 percent in 2011, compared with 8.7 percent in the U.S. Mexico’s national debt totals 27 percent of GDP; in the U.S., the debt-to-GDP ratio computed on a comparable basis was 99 percent in 2011 and is projected to be 106 percent in 2012. Imagine that: The country that many Americans look down upon and consider ‘undeveloped’ is now more fiscally responsible and is growing faster than the United States. What does that say about the fiscal rectitude of the U.S. Congress?” (More for subscribers.)

US Employment

Honestly, I expected that Friday’s employment report would show a much bigger increase than the 227,000 gain reported for total payrolls. I’m sure the number will be revised higher, just as January’s preliminary estimate was increased by 41,000 to a gain of 284,000. On the other hand, I wasn’t disappointed by the 428,000 jump in the household measure of employment. Even better was the extraordinary 879,000 increase in the household measure that is adjusted to be more comparable to the payroll measure. That’s more like it!

To derive a household employment concept more similar to the payroll survey, the Bureau of Labor Statistics data subtracts from total household employment agriculture and related employment, the self-employed, unpaid family workers, paid private household workers, and workers on unpaid absences, and then adds nonagricultural wage and salary multiple jobholders. The resulting employment series is then seasonally adjusted.
 

Now get this: Over the past three months, payroll employment is up 734,000, while the household measure is up 1.45 million. The household measure adjusted to be equivalent to payroll employment is up 1.54 million.

What about the notion that mild winter weather has distorted the payroll numbers to the upside and that there will be payback during the spring and summer months? I don’t buy it. I was, therefore, encouraged, in a perverse way, to see that construction and retail employment fell 13,000 and 7,400, respectively, during February. These are highly seasonal industries and lost jobs last month despite the unseasonably mild weather. There was plenty of positive data that require no perverse spins to make them so:

(1) The civilian labor force rose 476,000 during February after a 508,000 gain in January, the largest back-to-back increase since February 2003. It suggests that discouraged workers are starting to reenter the labor force because they perceive that the labor market is improving.

(2) In the household survey, full-time employment rose 563,000 in February, while part-time fell by 163,000. Full-time employment is now the highest since February 2009.

(3) Average weekly hours in manufacturing rose to 41.0 hours, a high for the series going back to 2006. The index of aggregate weekly hours rose 0.5% in manufacturing. This index was up 0.2% for total private industries. (More for subscribers.)

Stocks & QE

Would an extension of Operation Twist boost stock prices during the second half of the year? I think so, though I believe they can move higher without more monetary stimulus too. If you haven’t read Richard Fisher’s speech of March 5, you should. He is the president of the Federal Reserve Bank of Dallas. He is a nonvoting member of the FOMC, and among the frequent dissenters when he did have a vote last year. He voted against MEP. Mr. Fisher is “personally perplexed by the continued preoccupation, bordering upon fetish, that Wall Street exhibits regarding the potential for further monetary accommodation--the so-called QE3, or third round of quantitative easing.”

He does offer an explanation: “I think it may be because they have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery, rescuing the economy from the Financial Panic of 2008-09, and then kept the medication in the financial bloodstream to ensure recovery.” Let’s review the market’s medical chart to see how it responded to the injections and withdrawals of the Fed’s monetary medicine:

(1) The S&P 500 rose 36.4% during QE-1.0, which spanned from November 25, 2008 through the end of March 2010.
(2) The S&P 500 rose 10.2% during QE-2.0 from November 3, 2010 through the end of June 2011. It rose much more, by 24.1%, if we start the clock on August 27, 2010, when Fed Chairman Ben Bernanke first hinted that a second round of quantitative easing was on the way.
(3) Operation Twist was announced on September 21, 2011. Since then, the S&P 500 is up 15.9%.
(4) Between the end of QE-1.0 and Bernanke’s speech on August 27, 2010, the S&P 500 fell 9.0%. Between the end of QE-2.0 and the beginning of MEP, it fell 11.7%.

There is an even better correlation between the Fed’s QEs and expected inflation implied in the spread between the 10-year Treasury nominal and TIPS yields. During QE-1.0, expected inflation rose from a low of 0.12% the week of January 2, 2009 to 2.38% the week of January 8, 2010. During QE-2.0, starting with Bernanke’s speech on August 27, 2010, expected inflation rose from 1.55% to peak at 2.62% the week of April 15, 2011. During Operation Twist, it increased from 1.82% when the program was started to 2.25% at the beginning of March.

This helps to explain why stock investors are such junkies for QE. There is a high correlation between expected inflation in the 10-year TIPS and the forward P/E of the S&P 500 (Fig. 1). QE boosts inflationary expectations by lowering the risk of deflation. That benefits risky assets and their valuation. (More for subscribers.)

Global Super PMI

While the stock market was in the process of having its worst day so far this year, JPMorgan and Markit released their Global Manufacturing & Services PMI yesterday at 11 am (E.S.T.). Guess what it did? It rose for the fourth month running in February. In fact, it rose from January’s 54.5 to last month’s 55.5, which was the highest level in a year! The Devil is in the details: “Growth picked up in both the manufacturing and service sectors, although service providers maintained the stronger rate of expansion overall. Growth was heavily skewed towards the US. The US expanded at the fastest pace since February 2011, led by a strong increase in non-manufacturing output. In contrast, the global average excluding the US readings was almost four points lower (at 51.7) than the actual headline reading (55.5).”

I construct a similar Global Super PMI by taking an unweighted average of the manufacturing and non-manufacturing PMIs for the US, the Euro Area, the UK, and China. The JPMorgan index is a weighted average. My Super index fell last year from a high of 56.4 at the start of the year to a low of 50.0 during November. It rebounded to 52.6 during January and was little changed at 52.2 during February. It hasn’t been below 50 since June 2009. (More for subscribers.)

US Employment Indicators



It’s starting to look like a very big beanstalk could pop up in the labor patch on Friday when the Bureau of Labor Statistics will release February’s employment report. If so, then the Obama administration will undoubtedly take credit for having created so many new jobs. According to their narrative, they did so by bailing out the banks, the car companies, and the unions. Fed officials will say that their quantitative easing accounts for the pickup in jobs. My narrative is that the economy is performing better despite Washington’s reckless fiscal and monetary policies. It is profitable companies that are creating jobs. Let’s review the latest good news on this front:

(1) The ISM reported yesterday that the employment index derived from the monthly survey of purchasing managers in non-manufacturing industries was 55.7 during February. While that was down from 57.3 during January, it was still one of the best readings in over a year. Such high readings tend to be associated with month-over-month gains of at least 200,000 in private payrolls excluding manufacturing. Indeed, these jobs rose 207,000 during January.

(2) I also track the average of the employment indexes derived from regional surveys of businesses surrounding Chicago, Dallas, Kansas City, Philadelphia, and Richmond. These are all currently available through February. While these surveys are mostly billed as surveys of manufacturing companies, the average index doesn’t have any predictive usefulness for projecting monthly changes in factory payrolls. Neither, by the way, does the aggregate employment index included in the national survey of manufacturing purchasing managers. However, my regional average employment index is highly correlated with the monthly change in total payroll employment; it jumped from 9.0 during January to 15.1 during February. (More for subscribers.)

 

Global Manufacturing

The latest batch of manufacturing PMIs was a mixed bag. On balance, they show that global manufacturing continues to expand, though at a moderate pace. This is confirmed by the CRB raw industrials spot price index, which is my favorite indicator of global industrial production. It dropped last year by 11.5%. So far this year, it is up 6.3% through March 1, and has been moving sideways over the past couple of weeks. Let’s have a closer look at production around the world:

(1) China’s M-PMI edged up to 51.0 during February. The production index was at a nine-month high of 53.8, while the orders index rose to 51.0. There is a good correlation between China’s industrial production index and electricity output. Both slowed late last year, which explains why the People’s Bank of China has lowered bank reserve requirements twice since early December.

(2) In Europe, Greece, Spain, and Italy are in recessions with PMIs during February of 37.7, 45.0, and 47.8, respectively. That last number is actually an improvement for Italy from a recent low of 43.3 during October 2011. Greece is at a new record low. Spain remains in a plain. The rest of the EU’s PMIs are mostly around 50, which isn’t so bad given all the bad news coming out of Europe since last summer.

(3) In the US, the M-PMI was weaker than expected given the strength of regional business manufacturing surveys during February around Chicago, NYC, Philadelphia, Richmond, and Dallas. The national index edged down from a seven-month high of 54.1 during January to 52.4 during February with comparable declines in production, orders, and employment. (More for subscribers.)

S&P 500 Revenues & Business Sales

The stock market isn’t likely to get any jolts from earnings this year. The profit margin of the S&P 500 probably peaked last year. I don’t see any upside for it this year or next year. There could be some downside if labor costs increase at a faster pace as I expect. The biggest labor cost pressures may not be in America for most S&P 500 companies, which tend to be large multinational enterprises. They have been expanding their payrolls less in the US than abroad, especially in emerging countries where labor costs have been low. But that may be changing, as wages are rising faster now in countries like China and India.

If the S&P 500 companies can manage to maintain their profit margins at the 2011 levels, then earnings will increase at the same pace as revenues. During 2009, the bears dismissed the rebound in earnings by claiming that it was all attributable to unsustainable cost cutting and the revenues wouldn’t grow enough to drive earnings higher on a more sustainable basis. They were wrong.

S&P 500 revenues are highly correlated with manufacturing and trade sales, which include manufacturing shipments and distributors’ sales. The growth rates of the two are nearly the same. The business sales data are available monthly, while the S&P 500 revenues are compiled quarterly. The former was up 8.9% y/y through December and 29.4% since the cyclical low during April 2009, while the latter was up 10.4% y/y through Q3-2011 and 19.9% since Q1-2009.

What’s the outlook for revenues this year? They are unlikely to grow as fast as last year. I figure the growth rate could be roughly half as much, or around 5%. I am factoring in slower global economic growth this year with weakness concentrated in Europe. I see S&P 500 earnings up only 3% this year to $100 per share as a result of slight pressure on profit margins. Next year, I expect that both earnings and revenues will increase 7%. (More for subscribers.)