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Mixed Signals


After last week's spree of economic data, this is a relatively quiet week as investors await the start of second quarter earnings announcements. Besides a few S&P 500 companies reporting on Wednesday and Thursday, investors will be focusing on retailers when they report June same store sales results on Thursday.

Last week the Institute of Supply Managers reported that its index measuring economic activity slipped 1.7 points to 61.1. This was the lowest level since October 2003 and almost all components of the index showed a decline. One Wall Street economist commented that new orders have declined for six consecutive months and this has only happened four times and each of those was during recessions or was a prelude to one. The only problem with using these historical data points is that in each case the sub-index fell below 50, which indicates a contraction in new orders. Currently, the index is at 60, which is still higher than two-thirds of the months going back to 1948.

In one of the rare periods, the service sector of the economy is lagging the manufacturing sector, at least according the recent ISM surveys. The non-manufacturing report on business showed that business activity index fell 5.3 points to 59.9. This was the lowest point this year and steepest decline since October 2001. The decline is a bit of a mystery considering that seven of the nine components increased. Only backlog of orders and imports fell. Employment increased 1.1 points to 57.4, which is the highest since the index was started in 1997. This is interesting since the employment report from the Bureau of Labor showed that few jobs were created in June than economists had predicted.

Just as investors were getting used to 200,000 jobs being created each month, the June labor report showed a gain of only 112,000. The weaker than expected employment adds a degree of uncertainty regarding the strength of the economy and perhaps gives the Fed an excuse to remain "measured" longer expected last week. This will also make investors focus on other data points for clues on the health of the labor markets. The recent job cuts tally from Challenger, Gray and Christmas does not offer any conclusive evidence. The outplacement firm reported that 64,343 layoffs were announced last month, up from 59,715 last June, but down from 73,368 last month. Additionally, the company found that hiring intentions fell 31% from the previous month.

Last week, automakers reported June sales that were largely weaker than forecasted. The SAAR (seasonally adjusted annualized rate) was only 15.4 million compared to16.3 million forecasted. This was lowest sales rate since August 1998. Partially explaining the lower sales was the big month in May, which was 17.8 million. This continued the boom-bust cycle that started when automakers started relying heavily on incentives in 2001. Vehicle sales soar when incentives are introduced, which pulls ahead future sales causing he next month's sales to decline. This leaves the automakers with excess inventory which is cleared out with an increase in incentive or other promotion.

The weakness in June auto sales is especially troubling since incentives increased from May. According to Edmunds.com, incentives reached an all-time high of $2,747 in June. This was up 4.7% from last month and increased 9.6% from last June. Adding insult to injury to the domestic automakers is that they continue to lose market share, even as their incentives are up to five times as high as the imports. The table below compares the changes in incentives and market share for the domestic and foreign automakers.

  Incentives Market Share
Automaker June Change from May Market Share Change from May
GM $4,312 + $389 25.6% -1.3%
F $3,328, + $401 18.4% +0.1%
DCX $3,569 + $321 14.5% -1.0%
Japanese $921 + $22 34.5%* +0.3%*
Korean $1,868 + $55    
European $2,335 + $293 7.1% +0.6%

*Market share is combined for Japanese and Korean automakers

True to form, following the weak sales last month GM and Ford increased incentives this week. GM announced rebates of $5,000 on most of its SUVs and Ford increased its incentives by $1,000 on three vehicles and added $1,000 on a few others if the purchase is financed through their finance unit. These rebates are in addition to zero-percent financing for as long as five years. Other manufacturers are starting to aggressively increase incentives. This week, Volkswagen announced it will offer zero-percent financing for five years.

While auto sales cooled recently, the swift drop in mortgage rates sparked a jump in mortgage applications. As 30-yer mortgage rates fell 25 basis points last week, the Mortgage Bankers Association's mortgage index jumped 19.2%. Both purchase applications (up 15.0%) and refinance applications (up 27.6%) increased. The purchase applications index reached 500.9, only 0.7 points away from the record set in January this year. Second quarter results from MDC Holdings appear to confirm the strength in housing. On Tuesday, the homebuilder reported that its net orders rose 16% in the second quarter.

While earnings for most companies appear to be good, several technology companies have reported that second quarter earnings will not meet analysts' estimates. Enterprise software companies seem to be having the most troubles. Veritas, BMC, Siebel, and Peoplesoft all announced earnings would be lower than analysts forecasts. Most said that companies delayed purchasing decisions and the weakness was not due to underlying economic weakness. This has lead investors to fear that the recovery in business spending has come to a halt.

The majority of retailers will be releasing June same store sales on Thursday. Even thought retailers will benefit from easy year-over-year comparisons, the ICSC forecasts that same store sales will only advance 3.0% to 3.5% from last year. This would be a substantial deceleration from the 5.7% increase last month. This would also add to the conflicting data that investors have been forced to reconcile.

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