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It’s all about expectations. Most companies that announced first quarter earnings this past week reported earnings that were down. But the big news is that many key companies came in not as bad as expected, boosting the markets. Many came to believe that the worst of the credit crisis is over. Investors grew more optimistic, but based on the latest economic data the new confidence may not be well founded. However, there were some notable quarterly results that not only surprised on the upside but actually reflected earnings gains.
This past week ended strong but got off to a slow start as the gloom from Friday’s report of disappointing earnings from GE weighed on the markets. Also, Wachovia reported sizeable quarterly losses and Citigroup was downgraded. Stocks rose modestly on Tuesday as the flat reading for the Empire State manufacturing index was actually seen as good news. Better-than-expected earnings from some regional banks also supported equities on the second day of the week.
Wednesday was the highlight of the week as all major indexes jumped sharply. Better-than-expected reports from Intel, JPMorgan, and Coca-Cola led the markets upward. A stronger-than-expected gain in industrial production also helped to lift equities at mid-week. Thursday was flat to down modestly for major indexes as a jump in jobless claims and a very negative Philly Fed report weighed on equities. Positive support, however, did come from upbeat earnings reports from IBM and eBay. Gains were also strong on Friday with Dow component Caterpillar reporting earnings that beat expectations. Citigroup reported a sharp quarterly loss and took $13 billion in writedowns – largely for subprime losses. But investors took heart that Citigroup is cutting costs with an announced 9,000 in job cuts and that the bank's revenues were not as weak as expected.
The stock market made a huge comeback last week even though there was a sizeable list of companies reporting lower earnings though not as bad as expected. These included Wachovia, US Bancorp, JPMorgan, and Wells Fargo, among others. On the positive side, the energy sector generally gained. Also, a few companies actually glowed – including Intel, IBM, Google, Caterpillar, and eBay.
Last week, major indexes were up sharply as follows: the Dow, up 4.3 percent; the S&P 500, up 4.3 percent; the Nasdaq, up 4.9 percent; and the Russell 2000, up 4.8 percent.
For the year-to-date, major indexes are still down from year end as follows: the Dow, down 3.1 percent; the S&P 500, down 5.3 percent; the Nasdaq, down 9.4 percent; and the Russell 2000, down 5.9 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury yields rose almost steadily throughout this past week, ending significantly higher. Rates rose despite weak economic reports outside of inflation. But expectations played a role as some reports were not as soft as anticipated.
Retail sales bumped most rates up on Monday while on Tuesday a strong PPI report and better-than-expected Empire State manufacturing surveys were the culprits. A strong rally in the stock market, along with higher oil prices, further lifted rates on Wednesday as did an unexpected rise in industrial production, which boosted investor confidence in the economy. At week's end, better-than-expected earnings reports led funds out of Treasuries and into stocks.
 Treasury yields were up significantly last week as follows: 3-month T-bill, up 17 basis points, the 2-year note, up 39 basis points; the 5-year note, up 34 basis points; the 10-year bond, up 25 basis points; and the 30-year bond, up 21 basis points.
Euphoria in the equity markets has pulled funds out of Treasuries, bumping up rates, as have rising inflation fears, and a willingness to move fixed income funds into cheaper alternatives for safety and higher yields.
 Once again, oil prices continue higher into the stratosphere, setting a new record high. Spot oil jumped by about $2 per barrel during three of the trading days last week and rose by just over $1 another day. The “weak spot” for the week was when the spot price slipped 8 cents on Thursday. On the week oil was up a dramatic $7.06 per barrel, ending the week at a new record settle high of $116.75 per barrel for West Texas Intermediate spot.
Throughout the period, a soft dollar, strong seasonal demand, and speculation put upward pressure on oil. Early in the week, a report from China that it had sharply boosted diesel imports encouraged more speculators to jump into the market. Also, on Wednesday, reported inventories in the U.S. were much lower than expected. Oil spiked again at the end of the week after a Nigerian pipeline was shut down by militants.
While stocks rebounded this past week, economic data generally provided no basis for the gains other than the fact that a few indicators were not as bad as expected – a common theme last week. Nonetheless, the economic data were not encouraging as growth looks weak while inflation is hot.
 Retail sales made a comback in March but when you look at the details there are no real signs of strength in the consumer sector - just more inflation. Higher prices are leaving little for spending outside of essentials. Retail sales rebounded a partial 0.2 percent in March, following a 0.4 percent fall in February.
Overall strength was limited to essentials and a few other categories. Consumers did spend on the basics with gasoline store sales up 1.1 percent and food & beverage stores up 0.4 percent. Both of these and especially gasoline were likely lifted to a large degree by price increases. The only other notable gains were in nonstore retailers and sporting goods. The housing recession and tighter budgets pushed down sales for building materials and the key general merchandise category. Overall retail sales on a year-on-year basis in March declined to up 2.0 percent from up 2.9 percent the previous month.
 Fed officials have been stating that the economy will not turn back up until housing improves and the latest numbers indicate that housing is still headed in the wrong direction. Both housing starts and building permits weakened further in March. Starts plunged 11.9 percent in the month for a year-on-year decrease of 36.5 percent. Permits, which are forward looking, fell 5.8 percent in the month for a 40.9 percent year-on-year decrease for the very worst rate since 1991. Until inventories of new and existing homes for sale come down sharply, builders have no reason to start new construction. Also adding to homebuilders woes are a tighter credit market and a weak and uncertain jobs market. The bottom line is that housing is far from making a comeback. But next week we will get to see if there is any improvement “upstream” with reports on existing and new home sales.
 Industrial production made a comeback in March but almost all of the strength was in the volatile utilities and mining components – manufacturing remains soft. Overall industrial production rebounded 0.3 percent in March, following a 0.7 percent drop the prior month. The manufacturing component also turned back up but with only a modest 0.1 percent rise in the latest month after dropping 0.5 percent in February. Utilities output jumped 1.9 percent in March while mining output also came in strong with a 0.9 percent gain. The bottom line is that headline production overstated any apparent strength in March, but manufacturing is holding its own in contrast to expectations of a contraction. By industry, manufacturing gains were mixed – also suggesting that this sector overall is merely flat rather than in freefall.
 While manufacturing has paused in heading toward contraction, another factor may nudge this sector back down. Total business inventories rose 0.6 percent in February as business sales dropped 1.1 percent. This means that the inventory bulge is unwanted, and it pushed the stock-to-sales ratio up to 1.28 from January's 1.26. The biggest inventory gains were at the manufacturing and wholesale levels with increases of 0.5 percent and 1.1 percent, respectively. Retailers apparently are doing a better job of anticipating demand as their inventories rose a more modest 0.2 percent. While the inventory bulge will weigh on producers somewhat, the impact will not be as much in in years past since imports are a much bigger share of the economy. Wholesalers have a bigger share of imports than the other components. Also, manufacturing currently is relying more on foreign demand than in the past and a sizeable portion of manufacturing inventories is planned to meet export demand. Nonetheless, some U.S. manufacturers will have to adjust production to clear out unwanted inventory.
 Recent manufacturing surveys indicate that manufacturing is either flat or declining. The latest New York Fed survey found this sector leveling in the Empire State after two sizeable declines the months before. The general business conditions index came in at 0.6 in April, compared to readings of minus 22.2 in March and minus 11.7 in February. Although shipments jumped in the latest month, new orders were flat after a negative February. Given that both general conditions and new orders indexes followed negative months, in diffusion index methodology that means levels are still down.
Inflation news was not only bad but even worsened. Input prices jumped another 7 points to 57.3 in March while the prices received index jumped 5 points to 20.8. Manufacturers are experiencing significant cost pressures and are just starting to be able to pass some of these costs along.
 While the New York Fed’s index showed some signs of stabilizing, that was not the case for the Philadelphia Fed's manufacturing index. The headline business activity index fell to minus 24.9 from March's already dismal minus 17.4. This index has been in negative territory for five consecutive months and there is no sign of it getting better. New orders for manufacturers in the Mid-Atlantic region worsened to minus 18.8 in April from minus 9.3 in March.
 Prices, like almost everywhere else, are rising in the region with input prices at a severely elevated 51.6, along with indications that higher prices are being passed through to customers as output prices jumped nearly 10 points to 30.9.
The bottom line is that manufacturing on the national level may be weakening again while inflation is worsening.
The Conference Board's index of leading economic indicators may be pointing more to a flat economy than an outright recession. The index rebounded 0.1 percent in March after declining 0.3 percent in February and dropping 0.4 percent in January. A zigzag pattern may be emerging, making it difficult to forecast a full-fledged recession just yet. The index of coincident indicators also rebounded, gaining 0.1 percent after a 0.2 percent fall in February. Barring downward revisions, there now appears to be a good chance that the first quarter will not be the quarter that the recession officially begins.
The Fed’s own Beige Book points to weaker economic growth. The Beige Book prepared for the April 29-30 FOMC meeting was decidedly negative, noting that "economic conditions have weakened since the last report. Nine districts noted slowing in the pace of economic activity, while the remaining three -- Boston, Cleveland, and Richmond -- described activity as mixed or steady."
Adding to the economy's earlier woes is a softening in consumer spending with retail and auto sales weak. Housing was described as 'anemic' while the commercial construction sector has slowed. The service sector is mixed with transportation weak, business and health services expanding and others mixed. The outlook for manufacturing is 'subdued.' One clear positive is tourism, led by an influx of foreign visitors.
Regarding the all important issue of improvement in the credit markets, there appears to be a worsening at least at the consumer level. 'Credit quality was reported to have deteriorated, on balance, since the last report. Increased delinquency rates were noted by New York, Philadelphia, and Cleveland, while Kansas City reported that loan quality remained lower than a year ago. Widespread tightening in credit standards was reported, especially on residential and commercial real estate loans.'
Inflation is still a problem despite some softening in the labor markets. 'Labor markets were mostly described as weakening since the last report, though a few Districts reported ongoing shortages of skilled workers and some Districts noted wage pressures. Increases in input costs were widespread, accompanied by somewhat smaller rises in selling prices.'
Overall, the Fed’s own report is projecting weak or negative growth in the near-term combined with high inflation. While nothing like the 1970s, it looks like we are getting a clear dose of stagnation in coming months.
 Despite the continued softness in various sectors of the economy, inflation remains quite high. Consumer price inflation firmed in March after soft readings in February – indicating that the overall trend is still too high, especially for overall inflation. The March CPI rose 0.3 percent after no change in February while the core CPI strengthened to 0.2 percent after being flat the month before.
As expected, the main culprit in boosting headline inflation was a jump in the energy component which posted a 1.9 percent rebound after dipping 0.5 percent in February. Food was a little softer in March, coming in at 0.2 percent, following a 0.4 percent spike the month before.
We have seen some volatility in the monthly numbers but the trend is clear – inflation remains quite elevated. Year-on-year, the overall CPI stood at up 4.0 percent in March while the core rate came in at up 2.4 percent. A softening economy has had only limited impact in constraining inflation while higher import and commodity prices keep fueling inflation. Fed officials keep repeating that they are concerned about inflation but must fight recession first. Without relief with lower inflation numbers, the Fed may have to switch its focus sooner than expected.
 Food and energy inflation is still building in the pipeline toward the consumer as producer price inflation remains red hot at the headline level. Causing the headline number to explode were spikes in food and energy, up 1.2 percent and 2.9 percent respectively for the latest month.
 But a weak economy is keeping the core rate tamer than the headline rate. The core PPI rate eased to 0.2 percent, following a 0.5 percent spike the month before. Weak demand for passenger cars and light trucks were the key factors behind core moderation with declines in those components of 0.2 percent and 0.3 percent, respectively.
The continued bad news is that both the overall and core PPIs have been on an uptrend since mid-2006. The overall year-on-year rate stands at up 6.9 percent while the core rate has risen to a 2.8 percent year-ago pace. With commodity prices rising world-wide, there is little reason to expect a reversal of these trends any time soon.
There are further signs that the real economy in all key sectors is either flat or contracting while inflation remains considerably too high. If the economy picks up in the second half as Fed officials keep predicting, inflation will likely still be above the Fed’s comfort zone – meaning the Fed may have to dampen growth not far down the road. But the latest economic news indicates that the Fed may not get its growth rebound early in the second half. While there are no signs of a pending significant downturn, the latest data suggest that growth may be flat longer than many expect.
The week ahead slows down with only one major market mover — the durables orders report on Thursday. But we do also get key updates on housing with existing and new home sales reports.
Existing home sales rose in February, up 2.9 percent to a 5.030 million rate in what is rare good news for the housing sector. Sales of single-family homes, the most important category in the report, rose 2.8 percent to a 4.890 million rate, with sales of condos up 3.7 percent to a 560,000 rate. Lower prices helped nudge overall sales up in the latest month. Importantly, the improved sales rate helped ease supply on the market, which fell to 9.6 months from 10.2 months. While that is some improvement, the housing market still has a very long way to go to eliminating inventory overhand. But, looking ahead, the prognosis is not good. The latest data on pending home sales fell 1.9 percent in February.
Existing home sales Consensus Forecast for March 08: 4.95 million-unit rate
Range: 4.82 to 5.08 million-unit rate
Durable goods orders have been pointing to a return of weakness in manufacturing despite a recent uptick in industrial production. Durable goods orders fell 1.1 percent in February, following a 4.4 drop in January. Excluding the transportation component, new orders worsened 2.4 percent in February, following a 0.8 percent decline in January.
New orders for durable goods Consensus Forecast for March 08: +0.6 percent
Range: -1.7 percent to +2.7 percent
Initial jobless claims have been volatile but on average are reflecting a worsening in the backbone of the consumer sector as initial claims spiked back up in the week ending April 12, jumping 17,000 to a 372,000 level that is right at the four-week average of 376,000. These levels point to another month of trouble for payroll data. Continuing claims were also higher, up 26,000 in the April 5 week to 2.984 million for the highest reading in nearly four years.
Jobless Claims Consensus Forecast for 4/19/08: 375,000
Range: 375,000 to 380,000
New home sales are showing no signs of improvement and actually continue to spiral downward as sales weakened again in February to a 13-year low, down 1.8 percent to an annual rate of 590,000. This puts new home sales at a 29.8 percent year-on-year decline that offers no signal of improvement in the housing sector. Like existing home sales, inventory overhang is still a major problem. Supply on the market held unchanged in February at a 27-year high of 9.8 months.
New home sales Consensus Forecast for March 08: 580 thousand-unit annual rate
Range: 560 thousand to 600 thousand-unit annual rate
The Reuter’s/University of Michigan’s Consumer sentiment index continues to show a loss of resolve in the consumer sector with expectations for growth falling and expectations for inflation rising. The Reuters/University of Michigan consumer sentiment index fell to 63.2 for its mid-April reading vs. 69.5 in March. The 63.2 level is the weakest since the recessions and inflation of the early 80s. Inflation expectations have heated up with the one-year reading at 4.8 percent in the latest month, up 5 tenths from the final March reading. The consumer’s view of inflation is driven by weekly trips to the gas station and to the grocery store where inflation is at its worst.
Consumer sentiment Consensus Forecast for final April 08: 63.2
Range: 62.0 to 64.5
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