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June 16, 2005

Slower Economy = Refi Time
by Chad Hudson

The price of oil had a large affect on several of the economic indicators that were released this week. During May, the price of crude oil dropped from an average of about $53.00 per barrel in April to as low as $46.30. This drop in oil temporarily contained the pricing pressures that have been building over the past year.

Import prices dropped 1.3% in May, which was a much larger decline than the 0.4% drop economists were expecting. The price of imported petroleum dropped 6.5%, the largest drop since December 2004. Excluding petroleum, import prices dropped only 0.3%. Compared to a year earlier, prices on goods there were imported into the US during May rose 5.7% from last year.

Producer prices dropped 0.6% in May due to declines in food and energy. Excluding these two categories, prices increased 0.1%. Compared to last year, prices increased 3.5% and were up 2.6% excluding food and energy. While this is lower than the 4.1% increase economists forecasted, it marked the fourteenth consecutive month where prices rose more than 3.0% on a year-over-year basis. According to a story published by Bloomberg, three-quarters of the decline in producer prices was due to the drop in energy prices.

The decline in oil also caused consumer prices to drop more than expected. The consumer price index dropped 0.1% in May. Economists expected consumer prices to be unchanged from April. Excluding energy, prices increased 0.2%. On a year-over-year basis, the CPI is up 2.8%, which is the slowest increase since September of last year.

After auto makers reported lower sales in May and retailers reported that poor weather caused sales to be lower than plan, a drop in retail sales was expected. The advance retail sales report from the Commerce Department showed that sales dropped 0.5% in May. Motor vehicle sales dropped 1.6%. The lackluster results from retailers were confirmed with clothing stores reporting sales down 0.8% and department store sales dropping 0.9%. Lower gasoline prices caused sales at gas stations to drop 1.6%. While sales declined from April, on a year-over-year basis, retail sales were up 6.4%. April retail sales were revised higher by 10 basis points to 1.5%. Sales excluding auto sales were revised more significantly, to 1.4% from 1.1%. According to the ICSC, retail sales have started to accelerate in June. The ICSC reported that same store sales increased 3.7% last week.

Best Buy is one retailer that has been doing very well. This week Best Buy reported first quarter earnings of $0.51 per share, 50% ahead of last year and blew away Wall Street estimates of 30 cents. Revenues increased 12%, driven by same store sales growth of 4.4% and 9% new store growth. It is worth pointing out that last year, same store sales growth was 8.3%. The company did say they suffered from lower traffic, but had a higher conversion rate and a higher average ticket. Additionally, the company said that sales in June have tracked its plan of 4% comps. Due to the strength of the first quarter, the company increased its full year guidance to $3.10 - $3.25 from $2.95 - $3.10.

The Empire Manufacturing Survey is one of the first surveys published that measures if the manufacturing sector is expanding. Last month, the survey plunged to -11.1. While none of the other surveys indicated that the manufacturing sector contracted, they did show that growth had slowed. The Empire survey rebounded 22.8 points to 11.7. This survey has been volatile in the past and the Philadelphia Fed survey released on Thursday will help confirm if the manufacturing sector has started to accelerate. Contrary to the surveys, industrial production picked up in May to 0.4% after dropping 0.3% last month. The year-over-year growth slowed to 2.7%, which was the slowest year-over-year growth since January 2004.

Another indication that the manufacturing sector is slowing came from Illinois Tool Works. The manufacturer of fasteners and other industrial products said that its revenue grew 10% for the three months ending May 31, with base revenues up 3%. Analysts were not expecting the sequential slowdown from the 11% growth reported for the three months ending April 30. The company said that the "sequential weakness reflected continued slowing in a variety of the Company's North American and international end markets, especially market demand for short-cycle engineered products."

The Federal Reserve published the latest Beige Book on Wednesday. All twelve Federal Reserve districts reported that economic activity expanded from mid-April to the end of May. Philadelphia noted that growth has moderated in May and Boston and Cleveland "observed some unevenness across sectors." Retail sales were mixed throughout the country. The districts in the Northeast reported weaker sales with weather being the primary factor. One-third of the districts reported that, "high gasoline prices had a negative impact on retail sales. Residential real estate markets remained strong through most of the county, but there were some areas that were starting to show some weakness. Minneapolis reported that real estate markets were mixed and new home sales "weakened slightly" in Cleveland. In parts of the Dallas district it was noted that "the supply of new homes had outstripped demand." Manufacturing expanded during the period, but several districts reported that the pace has slowed, and some said it has leveled off. Several districts reported that manufacturers have plans "to increase capital spending, open or expand plants, and increase operations to meet expected demand." Higher prices are also the biggest concern most manufacturers have, especially higher energy costs. Labor markets continued to improve. Several districts reported that there was "difficulty finding specific types of workers."

The Manpower employment survey was released this week and showed that 31% of employers anticipate adding workers during the third quarter. Only 6% are planning a reduction in their workforce. This net employment outlook of 25% was the highest since 2000. After adjusting for seasonality, the index was 21% flat with the previous two quarters. Construction was by far the leading industry with a net employment outlook of 40%.

While inflation pressure eased in May, most of the decline was due to lower oil prices that have since climbed back to near the highs set in March. It is also becoming clear that the rapid acceleration in the manufacturing sector has ended and has entered a steady state of growth. As the manufacturing sector begins to slow, it is likely that the consumer will start to pick up the pace again. The recent drop in mortgage rates has spurred the Mortgage Bankers Association Mortgage Application Index to rise 17.4% last week to the highest level since April 2004. Much of the strength came from the refinance index, which jumped 25.6%. This will likely translate into consumer spending over the next few months.

Chad Hudson
Mid-Week Analysis
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