Friday, July 29, 2011
The debt debate continues to steal the spotlight from earnings and economic reports. The stock market has lost ground in recent days due to this uncertain environment even as corporate earnings reports have broadly come ahead of expectations.
With both sides in the debt debate sticking to their positions ahead of the Tuesday deadline, stocks will likely remain on edge today as well. The dismal GDP adds to the market’s woes.
While the GDP report was expected to be on the soft side, the extent of the weakness and the negative revisions to the prior quarter’s numbers were very disappointing.
The U.S. economy expanded at a lower than expected 1.3% rate in the second quarter, while the first quarter’s growth rate was sharply revised down to 0.4% from 1.9%. The softness is not concentrated in one area, but fairly widespread.
Consumer spending, which accounts for almost 70% of the economy, barely expanded at a 0.1% annualized rate, significantly down from the first quarter’s 2.1% pace. In a key positive in the report, business fixed investment increased at 6.3% rate, up from 2% in the first quarter.
There was positive contribution to the GDP number from net exports and inventory investment, both relatively ‘lower quality’ components. Stripping these two components out, we get the final domestic sales, which in loose terms can be thought of as a ‘core GDP’ measure. Final domestic sales were essentially flat in the second quarter, up 0.7%, the same as in the first quarter.
While the extent of the weakness in the GDP report and the negative revisions to prior periods were disappointing, no one was looking for fireworks from this report either. After all, expectations had steadily come down over the past six to eight weeks as it increasingly became clear that the first quarter softness had carried into the second quarter. Estimates for the second quarter GDP growth were north of 3% as recently as April.
The key issue now is the growth outlook for the coming quarters. Current expectations call for a snap back in the growth momentum in the third quarter and beyond as the negative effects of some of the temporary factors that held back growth dissipate.
We have yet to see any evidence of that in economic reports, but anecdotal evidence has been suggesting that manufacturing activities, particularly in the auto sector, has been coming back. Today’s Chicago PMI and next week’s ISM report will give us a better read on how the nation’s manufacturing sector did in July.
Lest we forget, we are in the midst of the second-quarter reporting season. This morning, we got a solid top- and bottom-line beat from Amgen (AMGN), while Merck (MRK) posted inline EPS on modestly higher than expected revenues. Oil major Chevron (CVX) also posted a beat. Gold producer Newmont Mining (NEM) came short of expectations even as its realized gold and copper prices increased 25% and 62% from the year-earlier level, respectively. Arch Coal (ACI) missed expectations and guided lower. After the close on Thursday, Starbucks (SBUX) came out bottom- and top-line beats and guided higher.
We should keep in mind though that the dominant issue in the market is not GDP or the earnings reports, it is the drama in Washington. Heading into the weekend and the Tuesday deadline without a resolution to this issue effectively ensures that everyone will remain on edge.
Sheraz Mian
Director of Research
Zacks Investment Research
