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Farrell: Clunkers Aren't Enough

Even with the initial cash for clunkers' surge in sales, total retail sales registered a 0.1% decline last month. Without autos, the decline was 0.6%. The consumer clearly is showing the effects of a high unemployment rate, stagnant wages, a depressed housing market, and limited access to credit. The consumer is 70% or so of total economic activity, and any attempt at an economic recovery needs some participation from the consumer.

The University of Michigan consumer sentiment survey surprisingly fell to 63.2 last month from 66 the prior month. Most had been hoping for a gain to the 69 level. This was viewed by the market as unsettling, since the last time we touched this level was in February, when both the stock market and the unemployment rate were much lower.

This week will get a reading on producer prices, but last week the consumer price index fell 2.1% on an annual basis vs. one year ago. This is the biggest decline since records were kept starting in 1949. I do like the way Brian Wesbury of FT Advisors looks at this statistic, since he acknowledges the annual decline but notes that the last three months' consumer prices have increased at 3.4% annual rate. The problem with a decline in prices is that purchases tend to get deferred in the hopes that things will get cheaper tomorrow, but that of course can create a deflationary spiral.

So on Friday, the market dealt with all of this news by selling off inflation-sensitive sectors like materials, industrials, energy stocks, and consumer discretionary stocks. The WSJ had an interesting article on Saturday dissecting the industrial group. Of the 53 names in that S&P category, 75% beat analysts' estimates by an average of 10%. The better-than-expected earnings did not come from revenue growth but rather from cost-cutting, lower tax rates, currency translation gains, and other one-time non-recurring items. It's my guess that the market will swing back and forth as economic news hints of either inflation or deflation. While I think the next real threat could be inflation (and most seem to agree, with the debate centered on when Uncle Ben should start to take the punch bowl away), I don't think the threat of deflation is dead. I would be looking at the struggle between the price of oil and the dollar. My guess is that oil will decline since inventories are so high. The stock market is probably range-bound, which is no great insight, but there seems to be confusion and nervousness, which evidences itself in a complete lack of volume.

This week we will see a lesser flow of economic news, and the stuff we get is centered on production and housing. Both the Empire State and the Philadelphia Fed manufacturing indexes will be released, and look for both to be in the very low single-digits. The NAHB housing index comes Monday, and a number around 18 would be OK. We don't need more housing starts, with the large inventory of unsold homes looking for buyers, but that number should be around 550,000. Existing home sales will be released at the end of the week, and we are hoping the number hits 500,000.

With the swoon (albeit a modest one) towards the end of the week, it appears the market has feasted on better-than-expected earnings long enough and will be searching for other news to help prop up stock prices. But a bit of a correction is called for and would be a good thing.
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