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April 19, 2007

Economists Must Live on Communes
by Chad Hudson

Economic data released over the past week was much friendlier to those hoping for the Fed to start easing. The bond market cheered the March CPI report released on Tuesday. While the headline number revealed consumer prices increased 0.6%, the fastest pace since last April, economists and bond investors focused on the 0.1% increase in core inflation. Compared to last year, prices increased 2.8%, 40 basis points higher than February. Excluding food and energy, prices rose 2.5%, down 20 basis points from last month. The year-over-year change in the "core" rate was the lowest since May 2005. It seems more and more economists are living on communes where they don't have to purchase food or use energy. Food & beverage increased 3.3% from last year, the largest increase since October 2004. Food at home increased slightly faster then restaurant prices, 3.4% verses 3.3%.

Retail sales increased 0.7% in March, which was the largest increase since December. Additionally, February sales growth was revised to 0.5% from 0.1% initially. Compared to last year sales grew 3.8%, the same as last month, which was the slowest pace since July 2006. Much of the weakness was in auto sales, up 2.7% year-over-year. Excluding auto sales, retail sales increased 4.2%. Building materials declined on a year-over-year basis for the fourth consecutive month. Sales at electronics stores were flat with last year. This was the first time since April 2003 when sales were not higher than the year ago period. Clothing stores sales jumped 10.7% aided by an earlier Easter, however, department stores missed out and posted a 2.0% decline. Consumers also increased spending at restaurants, up 6.8% compared to last year.

Housing starts unexpectedly increased last month, but the gain was due to February starts being revised lower. Homebuilders broke ground on an annualized 1.525 million units. This was 23,000 more than economists forecasted, but February starts were revised lower by 19,000 units. The number of permits increased by 12,000 in March, which surprised economists that expected a drop of 22,000. While this sounds like a much needed positive development for the homebuilding industry, the number of permits issued was only 31,000 more than the low point reached in November and remains almost 800,000 lower than the high hit in September 2005. While the housing starts data appears to be stabilizing, the National Association of Home Builders Index fell three points to 33, the lowest level this year and only three points higher than the low set in September 2006. The present sales index fell three points to 33 and is only one point higher than the low set in September 2006. The future component fell six points to 44 after being at 50 or better for the previous two months.

The weak housing market has rippled through several other industries. The transportation sector has experienced significant weakness caused by lower volumes of construction materials. CSX reported that net income fell 2% as sales rose 3.9% during the first quarter. Volume fell 4%, but was more than offset by an 8.1% jump in yield. Volumes were negatively impacted by a 14% drop in automotive volumes and 13% declines in forest products along with food and consumer. Volume did improve in March, down 1% to 2%, compared to the 4%-5% drop in January/February. Automotive shipments are expected to fall during the second quarter as the auto-industry continues to restructure and closes plants. This will be the only segment of the business that is forecasted to have a drop. The company expects business to increase in seven of its other nine markets with emerging and forest products being neutral. The trucking firms have also seen weak volumes. First quarter revenue for Con-Way dropped 4.2%. The company did indicate that tonnage started to improve in March and the trend has continued into April. JB Hunt's earnings were even with analysts' estimates, but were a penny lower than last year's results. Werner reported first quarter earnings of $0.21 per share, which was two pennies lower than consensus estimates and 24% lower than last year's earnings. Revenue did increase by 2% compared to last year, but weak pricing caused the company's operating ratio to plunge 210 basis points.

Eaton commented that high energy prices have caused lower capital expenditure activity. The company also noted that it has seen a stronger than expected rebound in the Brazilian agriculture market along with strength in Europe, especially Germany. The industrial rebound is slower than initially forecasted. Previously the company thought the Fed would cut rates in June, but now sees that happening later in the summer or fall.

The company also saw more activity in March than in January or February. The company is also hopeful that the inventory liquidation has ceased as orders got better in March then they were in January and February. The weaker dollar has aided in increasing the competitiveness of American manufacturers.

"And so trucks, which are produced in Europe or the U.S. which would be headed outside of Europe or the U.S., it actually is a little better to produce them in the U.S. right now. And you have seen in the U.S. orders for NAFTA heavy-duty trucks that there has been an increased percentage of the trucks, which are going to the Middle East and are going to Mexico. And many people are beginning to posit that what you're seeing is on the fringe or on the margin, some of the trucks that would have been produced in Europe and sent to those regions are actually, you can get a better price by producing them in the U.S. right now. I think it's a little early from a personal point of view to announce that as a fact. I think it's a theory that many people are positing, but that may be part of what is impacting Europe at the margin as well."

United Technologies disclosed that the weak dollar helped it revenue and profit growth. Overall the lower dollar accounted for three percentage points of the total 16% growth.

It was also interesting that the company has stopped putting on hedges on copper a few months ago. Companies have commented that the soaring commodity prices have made hedging strategies much more expensive. As companies forgo hedging strategies, the risk of lower margins escalates.

Chad Hudson
Mid-Week Analysis
PrudentBear.com