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First quarter earnings from key companies fell below expectations and led equities down significantly for the week, plunging year-to-date losses back down further. In the race to improve company outlooks, this earnings season clearly has stumbled coming out of the gate. Early earnings reports and the latest warnings suggest that investors are still soaking in the meaning of the current economic contraction for stocks.
 Stocks were mixed and little changed overall on Monday but earnings season got off to a bad start as Alcoa – the traditional first Dow company to announce – reported quarterly earnings that were down from a year-ago and missed low on sales. Alcoa was hard hit by higher energy prices and a softer economy. Favorable news for the day came from a report that Washington Mutual would be getting $5 billion in capital from investors, giving markets hope that the worst in the credit crunch is over.
Stocks declined on Tuesday on profit warnings from chip-maker AMD and on negtive comments on the economy in the Fed’s FOMC minutes. The news from AMD was seen as a sign of weakness in the consumer electronics industry while the FOMC minutes indicated that the Fed downgraded its economic forecast for the first half of 2008 to a contraction. On Wednesday, markets were weighed down by a profit warning from UPS. While a hit to earnings from higher fuel costs was not a surprise, markets were concerned about the slowing in UPS business since the company is seen as a bellwether for the overall economy. Also on Wednesday, financials fell after several firms disclosed increased exposure to difficult to value assets known as Level 3 assets. Apparently, we keep going into extra innings on liquidity issues. Maintenance problems and flight cancellations weighed on American Airlines all week but pulled the stock down notably on Wednesday.
The one broad up day for the week was Thursday with techs leading the way on news that Yahoo! and AOL could merge. An upgrade of Cisco by Morgan Stanley also helped techs.
Friday brought more sobering news on earnings as heavy-weight GE reported weaker-than-expected earnings. GE is seen as even more of a bellwether than UPS and some consider GE stock to be like a mutual fund because of the diversity of businesses within GE. Also, dragging stocks down was the University of Michigan’s consumer sentiment index which fell to the lowest level since March 1982. Overall for the week, the earnings and warnings news point to continued weakness in the consumer and financial sectors.
Last week, the techs and small caps led decline in equities. Major indexes were down substantially as follows: the Dow, down 2.3 percent; the S&P 500, down 2.7 percent; the Nasdaq, down 3.4 percent; and the Russell 2000, down 3.6 percent.
For the year-to-date, major indexes remain negative as follows: the Dow, down 7.1 percent; the S&P 500, down 9.2 percent; the Nasdaq, down 13.7 percent; and the Russell 2000, down 10.2 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury yields mostly edged down this past week, showing much less intraweek volatility than in recent months.
On Monday, rates were nudged up as traders moved back from excessive worrying over the prior Friday’s reported losses in employment. Rates, however, dipped back down Tuesday afternoon after the Fed’s FOMC minutes showed FOMC members having a more negative view of the economy for the first half of this year. Rates slipped further on Wednesday on disclosure by key financial firms of holding Level 3 assets that are hard to value and sell.
Rates rebounded on Thursday on a sharp drop in jobless claims. But rates eased again on the last day of the week on news of GE’s weaker-than-expected earnings — the news hinted at a weaker economy and also investors moved funds to Treasuries on flight to safety.
 Treasury yields were mostly down a little last week as follows: 3-month T-bill, down 18 basis points, the 2-year note, down 7 basis points; the 5-year note, down 5 basis points; the 10-year bond, unchanged; and the 30-year bond, down 1 basis point.
The yield curve was little changed this past week except for the 3-month bill being down somewhat. The bottom line is that flight to quality and expectations of near-term Fed easing are keeping short rates extremely low while inflation expectations have created a floor for the longer rates.
 Another record high for oil prices – it is getting to be a far too common occurrence. Last week, the two biggest daily spikes were on Monday and Wednesday with one-day gains of $2.86 and $2.41 per barrel, respectively, for spot West Texas Intermediate. Monday’s jump was due to concern over low gasoline supplies and due to investors speculating on oil as an inflation hedge. Wednesday’s surge was due to a surprisingly large drop in crude supplies, leading to an intraday high of $112.21 per barrel and settling at a record high of $110.87 per barrel. Prices eased a little on Thursday and Friday on comments by Saudi officials that they would not be cutting back on production and on the IEA lowering its forecast for global oil demand.
The spot price for West Texas Intermediate jumped $3.40 per barrel net for the week to end the week at $109.63 per barrel, down $1.24 from the record high of $110.87 set on Wednesday of this past week.
This past week we had limited economic news with key data coming from the foreign sector — the monthly trade deficit and import prices. The trade numbers show some U.S. businesses planning poorly and the import price data are scaring up inflation fears. We also got more information on Fed thinking from the latest FOMC minutes with more background detail on the credit markets, Fed forecasts, and policy concerns.
 The trade deficit unexpectedly worsened sharply in February as American businesses appear to have badly overestimated what they need on the shelves and in showrooms to meet consumer demand. The overall U.S. trade gap grew to $62.3 billion from a $59.0 billion shortfall in January. For the latest month, exports rose 2.0 percent while imports jumped 3.1 percent.
The biggest jump in imports was in automotive and consumer goods – where demand is soft. Capital goods imports rose only modestly. Export strength was in industrial supplies and foods, feeds & beverages. February exports set another record high.
Also unexpectedly, the oil gap narrowed while the nonoil gap expanded sizably. The petroleum gap shrank to $32.5 billion from $35.3 billion in January. This deficit fell even though the price per barrel rose to a record $84.76 from $84.09 in January. The nonoil trade gap widened to $37.8 billion from $32.5 billion the month before.
For this report, there is some divergence in the near term statistical impact and the longer impact on current inventories, future imports, production, and exports. In the near term, February’s trade report will lower first quarter GDP estimates for net exports and may well be what tips the overall GDP numbers into negative territory. But there could be an offsetting increase in inventories as more imported consumer goods sit unsold. Over the longer run, the jump in imports in February will weigh on imports in coming months. Consumer spending is weak and businesses cannot justify importing at such high levels for automotive and consumer goods. Until the consumer sector picks up, we will see a slowing in imports – the only question is when the slowing will show up in the data, not if. Meanwhile, expect a weak dollar and healthy overseas growth to keep U.S. exports on a record setting uptrend.
 The weaker dollar and strong demand overseas is jacking up imported inflation for U.S. consumers. Overall import prices surged 2.8 percent in March pushing the year-on-year rate to 14.8 percent - its worst year-on-year level in more than 25 years of data. Import price pressure is deep and widespread with non-petroleum import prices up a record 1.1 percent. The year-on-year rate for the category is up 5.4 percent - the worst reading since the mid 90s. Petroleum import prices jumped 9.1 percent in the month, more than reversing a 1.9 percent decline in February.
 The import price index has a lot of demand and supply senstive commodities and the commodity components have been leading this index upward. But even the narrowly defined “consumer goods excluding autos” component is showing upward pressure, jumping 0.5 percent in March after a 0.4 percent gain the month before. The 2.7 percent year-on-year pace portends badly for the CPI and is the highest rate since 1992.
The latest FOMC minutes can best be described as the gloomiest in some time and placing the Fed squarely between a rock and a hard place as economic growth has been downgraded in the Fed’s view while inflation is not cooperating. Even though two voting members of the FOMC voting against lowering the fed funds target rate, some members saw the economy as possibly being headed toward a very contracted recession.
"In the Committee's discussion of monetary policy for the intermeeting period, most members judged that a substantial easing in the stance of monetary policy was warranted at this meeting. The outlook for economic activity had weakened considerably since the January meeting, and members viewed the downside risks to economic growth as having increased. Indeed, some believed that a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market."
This view was substantiated to a large degree by the Fed's staff economic forecast which lowered its growth forecast - although not calling for a recession as severe as some. The Fed staff still sees recovery in the second half of 2008.
"In the forecast prepared for this meeting, the staff substantially revised down its projection for the pace of real GDP throughout 2008. The staff projection showed a contraction of real GDP in the first half of 2008 followed by a slow rise in the second half."
There were several themes behind the lowering of the forecast for economic growth. These included a continuing credit crunch, depressed housing and with its effect on the consumer, a weaker labor sector, and higher energy costs weighing on the consumer.
The Fed recognized that inflation is still a problem but seemed to be engaged in wishful thinking about solving it. The Fed minutes give a long list of reasons why inflation is high but then simply rely on weaker economic growth to lead to an easing of inflation.
The bottom line is that the Fed has a difficult situation to address in terms of unfreezing the current credit crunch while at the same time anticipating when the recent liquidity injections should be withdrawn so as to help bring inflation down. As noted by FOMC members, the current issues are complex with subprime asset valuation still an issue, consumer debt becoming an issue, housing still some time from recovery, but with world-wide demand keeping inflation a nagging problem. While there is a good chance that the economy will recover in the second half, there is little reason to expect it to be robust-and inflation will still be lingering.
 This past week’s release of Fed minutes which showed FOMC members more worried about recession helped raise expectations again that the Fed will cut the fed funds target rate to 1.75 percent and keep it there for the rest of the year. Weak earnings reports also added to these expectations. Nonetheless, traders in the fed funds futures market still expect the Fed to start a moderate rate hike cycle before spring of next year.
Early earnings reports for the first quarter point to continued weakness in consumer and financial sectors. While the worst of the credit crunch is likely over, its effects on the markets and the economy are likely to linger more than we had been expecting.
The week ahead is jam packed with market moving indicators—retail sales on Monday; the PPI on Tuesday; and the CPI, housing starts, and industrial production on Wednesday. Also, the Beige Book prepared for the April 29-30 FOMC meeting is released Wednesday afternoon. Other indicators include updates on manufacturing with the Empire State and Philly Fed indexes on Tuesday and Thursday, respectively.
Retail sales unexpectedly dropped in February and indicate that the consumer sector is under a lot more stress than previously believed and no longer can keep the economy out of a downturn. Retail sales fell 0.6 percent in February, following a 0.4 percent gain the month before. Excluding motor vehicles, retail sales declined 0.2 percent after rebounding 0.5 percent in January. More recent data show U.S. made autos and light truck sales slipping in March while chain store sales have been anemic. Retail sales go into the calculation of durables and nondurables components of personal consumption in GDP and another drop in retail sales will likely push GDP growth for the first quarter to zero or below.
Retail sales Consensus Forecast for March 08: 0.0 percent
Range: -0.4 to +0.5 percent
Retail sales excluding motor vehicles Consensus Forecast for March 08: +0.2 percent
Range: -0.3 to +0.7 percent
Business inventories are showing signs of developing some unwanted overhang and that could dampen manufacturing activity. Business inventories rose 0.8 percent in January, following a 0.7 percent rise in December. These gains would point to inventory building had it not been for a 1.5 percent January jump in business sales. But sales data from February have been weak, highlighted by retail sales in for that month. Also pointing to a likely jump in inventories was a surge in February for imports of motor vehicles and consumer goods. More recently, manufacturers’ inventories rose 0.5 percent in February – somewhat slower than the January gain of 1.3 percent but still elevated.
Business inventories Consensus Forecast for February 08: +0.6 percent
Range: +0.4 to +0.7 percent
The producer price index has been giving mixed signals lately with the core rate showing some inflation heat. The overall PPI rose a moderate 0.3 percent in February, following a 1.0 percent surge in January. However, the core rate inflation jumped to a 0.5 percent increase, following a 0.4 percent jump the month before. For the core PPI, the February increase was led by pharmaceuticals, passenger cars, and light trucks. Headline inflation was moderated by a dip in food prices. Nonetheless, the trend for both headline and core inflation still appears to be up despite recent weakness in the U.S. economy as demand is still very robust overseas.
PPI Consensus Forecast for March 08: +0.5 percent
Range: 0.0 to +1.8 percent
PPI ex food & energy Consensus Forecast for March 08: +0.2 percent
Range: +0.1 to +0.5 percent
The Empire State manufacturing index continues to be in recession territory – and worsened further in the latest month. The Empire State index fell to minus 22.2 in March from minus 11.7 in February, showing contraction in new orders, shipments and inventories. Pressures on input costs, however, were severe with prices paid up more than 3 points to 50.6. But only some of this pressure is feeding through to final prices as prices received came in at 15.7, down about 2 points in what could be considered a mild positive. The price numbers mean that either producers will find a way to pass along higher costs or will suffer slower profits.
Empire State Manufacturing Survey Consensus Forecast for April 08: -16.0
Range: -22.2 to -12.0
The consumer price index surprised the markets last month with unchanged readings for both the headline number and the core CPI in February. While the markets saw the numbers as a significant improvement in inflation, the more accurate interpretation is that February was merely coming off a strong January and that trend inflation is likely in between the two months. January had been notably strong with headline and core numbers coming in at 0.4 percent and 0.3 percent, respectively. What pulled February so low? Helping to ease core inflation were declines in prices for apparel and for new & used motor vehicles. Also, medical care inflation slowed sharply from a high number the month before. Also helping to flatten the headline number was a drop in energy costs. All of these factors could – and likely will – reverse in March.
CPI Consensus Forecast for March 08: +0.3 percent
Range: 0.0 to +0.5 percent
CPI ex food & energy Consensus Forecast for March 08: +0.2 percent
Range: +0.1 to +0.3 percent
Housing starts may have gotten some temporary bounce from atypically favorable winter weather but permits are still pointing down. Starts are still a little above their recent bottom even though falling back 0.6 percent to a 1.065 million unit annual rate. February’s modest slippage followed a 7.1 percent surge in January. However, permits came in much weaker. While, starts can be affected by how seasonally typical the weather is, permits are less immune to vagaries in the weather. Building permits dropped 7.8 percent to a 0.978 million unit pace after declining 1.8 percent the month before. More recently, pending home sales continued to weaken, suggesting no improvement in starts in the near term.
Housing starts Consensus Forecast for March 08: 1.018 million-unit rate
Range: 0.980 million to 1.100 million-unit rate
Industrial production has recently joined housing as a sector in contraction. Overall industrial production dropped 0.5 percent in February, following a 0.1 percent gain the month before. The manufacturing component declined 0.2 percent in the latest month while utilities output dropped 3.7 percent and mining output rose 0.4 percent. The outlook for March production is not good as new factory orders have fallen the last two months, declining in January and February by 2.3 percent and 1.3 percent, respectively. Also, the March employment report showed manufacturing production hours falling by 1.0 percent for the month.
Industrial production Consensus Forecast for March: -0.1 percent
Range: -0.6 to +0.3 percent
Capacity utilization Consensus Forecast for March 08: 80.3 percent
Range: 79.9 to 80.7 percent
The Beige Book being prepared for the April 29-30 meeting is released this afternoon. FOMC members and markets will be looking over this report for a number of key issues. Are the labor markets softening further? Has the credit market loosened up? Are consumers retrenching further? Are there any signs of inflation easing? Recent data on these issues have been pointing in different directions for monetary policy. While the economy is slipping, inflation is not and the Fed has to start worrying about when to stop easing due to inflation concerns yet at the same time make sure the economy is going to rebound, and this rebound will play a key role in the Fed decision on rates on April 30.
Initial jobless claims swung back lower in the week ending April 5 declining by 53,000 to a comparatively solid 357,000 level. Recently volatile readings likely have been affected by seasonal adjustment difficulties. The latest week’s decline was the largest fall in 2-1/2 years. Markets will continue to watch the claims numbers for signs that the labor market is not worsening. While most agree that the U.S. has entered a dip in economic activity early this year, there is uncertainty whether the decline will be long enough to become a recession and the strength of the labor sector will be critical in that determination.
Jobless Claims Consensus Forecast for 4/12/08: 375,000
Range: 360,000 to 385,000
The Conference Board's index of leading indicators has been pointing toward recession in recent months while the coincident index has yet to show recession – unless there are downward revisions. The Conference Board's index of leading economic indicators declined 0.3 percent in February, following drops of 0.4 percent in January and 0.1 percent in December. For the latest month, component declines were seen in stock prices, initial unemployment claims, vendor performance, building permits, and consumer expectations. However, the coincident index does not yet indicate we are in recession. The coincident index is heavily considered by the National Bureau of Economic Research when marking the start of recession. This index was flat in February, following no change the previous two months. But the numbers do get revised and the biggest component is payroll employment which fell in March and was revised down for January and February. Look for the coincident index to be revised down and then provide key validation that a contraction started in January.
Leading indicators Consensus Forecast for March 08: +0.2 percent
Range: -0.1 to +0.4 percent
The general business conditions component of the Philadelphia Fed's business outlook survey index is still pointing to recession in manufacturing in the mid-Atlantic. The Philadelphia Fed's business activity index was negative for a fourth month in a row in March, coming in at minus 17.4 vs. minus 24.0 in February. New orders showed less severe but still similar results, at minus 9.3, compared to minus 10.9 in February.
Philadelphia Fed survey Consensus Forecast for April 08: -15.0
Range: -25.0 to -10.0
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