Wednesday, May 25, 2011

Concerns about the near-term growth outlook of the U.S. economy may have started to move beyond the debate stage and start showing up in estimates for second quarter GDP growth rate.

The estimate cut by economists at JPMorgan (JPM) this morning to 2.5% from 3.2%, citing temporary factors, could be an early sign of the emerging trend on the estimates front. Today’s soft durable goods report for April, coming after a slew of mixed reports on the nation’s manufacturing picture in recent days, will likely hasten that trend. 

The economy’s weak growth pace in the first quarter was attributed to transitory factors that were expected to reverse in the coming quarters. It was this expectation that made the market comfortable in second quarter GDP growth expectations in the 3% to 3.5% range. But if the recent trend of soft economic reports remains in place, those growth expectations will have to come down. The pullback in commodity and stock prices this month and sectoral rotation into more defensive names reflects this view.

The April Durable Goods report came in weaker than expected this morning. While the report was expected to show some weakness due to lingering effects from the Japanese disaster in March, the extent of the negative swing from the preceding month’s growth pace was very disappointing. The report was weak all around, both at the headline as well as core levels.

If the soft capital spending picture in April is due to supply chain disruptions resulting from the Japan disaster, then the weakness will likely reverse in the coming months. The alternative may be reflective of a decelerating trend in the economy that a number of other indicators are also pointing to. We should keep in mind though that the durable goods report has a well-documented history of giving a soft read in each quarter’s first month.

The first quarter earnings season is effectively over, though we still have a handful companies reporting. Costco (COST) came ahead of earnings and revenue expectations this morning, as same-store sales strength offset gross margin pressures. Toll Brothers (TOL), the luxury homebuilder, missed expectations. Hormel Foods (HRL) beat revenue expectations, but margin pressures left it modestly short on EPS. Applied Materials (AMAT) came out with better than expected EPS and revenue numbers after the close on Tuesday, but provided lackluster guidance.

With concerns about Europe’s debt situation not far from investors’ radars, today’s weak Durable Goods report will likely feed into the emerging narrative of an economy that is facing growth challenges.

Sheraz Mian
Director of Research
 
Zacks Investment Research