Wake Up Call - Retail Sales Slump, Inflation NOT Softening

The Dow, S&P 500 and NASDAQ indices have opened higher, as investors initially misinterpret key data. The retail sales report for April, which showed far worse than expected weakness, is being interpreted as a reason for Fed rate reduction. My friends, consider what is before you. Consumer softening portends trouble for your economy, more severe than is widely anticipated. Though I agree Fed rate cut will come, I point out that it will be after corporate profits plunge, layoffs surge and economic recession entrenches. I should not fail to mention that global equity markets should tank as a result. Equity markets seem to be ignoring the headline PPI increase, for the perceived good news in the core figure. Price rise in energy expenses and materials costs will eventually be passed forward to the consumer, especially as revenues decrease for American firms. The American consumer is more important to the multinational firms in the Dow and S&P 500 than are their foreign sales. Therefore, we would take profits. We provide further sector specific advice below. Please find significantly more detail below.

Asia:
Hang Seng Index -1.34%; Shanghai/Shenzhen CSI 300 -0.59%; NIKKEI 225 -1.03%; S&P/ASX 200 -0.91%; Taiwan TAIEX -0.81%; BSE SENSEX 30 +0.18%; KRX 100 +0.13%; Ho Chi Minh +1.92%

U.K., Europe & Middle East:
DJ STOXX 50 Index -0.15%; FTSE 100 +0.22%; CAC 40 -0.49%; DAX -0.51%; Russian RTS Index -2.55%; ASE General -0.63%; Tel Aviv 25 na; Tadawul All Share na; DFM General na

Our value-added take on today's key news:

• *** April retail sales decreased 0.2%, far short of the 0.4% rise that was expected by the consensus of economists, but in line with Wall Street Greek's view expressed in our weekly report and again all week. More importantly, when excluding the 1.7% increase in sales at gas filling stations and weaker automobile sales, retail sales fell 0.2%. Surprisingly, the media and the market seem to be initially focusing on how weak economic data might play into the Fed's hands, allowing it to lower rates. We warned about this naivete' yesterday, and we reiterate that the more important takeaway from this data is that the consumer is showing signs of softening. The consumer is a pillar of strength for this economy, and if she stops spending, even your large American multinationals will show operational impact, as will unemployment. In other words, this is a sign that we could fall into recession soon. This is not good news for the earnings of American firms, the earnings of Chinese exporters or the equities of global markets. In fact, we are again stating that the ongoing story of the softening consumer will be the key driver of equities this year. Rising expenditures at the supermarket and gas station, and difficulty to borrow in a much tighter lending environment, are finally cracking the consumer. We think this will have impact to consumer discretionary and energy stocks this year, and we would underweight consumer discretionary, while maintaining a neutral weighting in energy for now. Financials should soften again in the very short term, but be of the first to benefit from signs of a Fed rate cut. We are underweight the financial sector for now, with an eye on raising the weighting later. Health care and consumer staples should generally benefit from capital flows (overweight), while materials should see weakness. Materials have the offset of developing market growth playing a role for now, but we anticipate materials will weaken as well. We are neutral the technology and telecommunications sectors.
• *** There was some more naivete expressed after the PPI data release this morning. Producer prices rose 0.7% in the month of April, above the 0.6% consensus view. But! market commentators pointed to the Core PPI figure, which was unchanged again. You know by now how adamant I am about the ignorance in ignoring rising food and energy prices. I'm getting tired of saying it, but I have to pound it in until I see it digested by the general public. Food and energy prices are not to be discounted, as they are not rising on seasonal patterns. They are rising on secular trends that I see continuing. Population growth and global industrial development, along with new uses for food, should continue to drive prices for all consumables higher. Energy markets are tight, as emphasized again by the IEA today. Alternatives are coming along, but we face the prospect of war in the oil rich Middle East. If oil prices weaken on economic recession as I expect, I will pound the table for oil again later. The supply/demand dynamics are unchanged over the long term. Developing industry globally is sucking up supply faster than we can develop new sources. The idea that price rise in energy has not been passed along yet is irresponsible. It will be. Corporations will bear as much as they can, and then they will layoff workers and pass energy costs along to consumers. Look forward my friends, and the view is clear.
• *** Alan Greenspan today stated that he still believes the economy has a one-third chance of falling into recession this year.
• *** The RBC Cash Index shows consumer confidence somewhat steady, though expectations of most Americans is that things will get worse in the next six months.
• *** Earnings season rolls on, so catch Yahoo!'s calendar here.
• *** The Chinese market is getting tense, as investors fear Friday moves of government regulators seeking to slow speculation without starting a landslide. Chinese regulators have been making moves on Fridays after market close in order to allow investors to sleep on the news before trading opens again. The government is set to open foreign investment to Chinese investors, with hope that a wider investment spectrum might dilute speculation in Chinese shares. Chinese stocks weakened today on concern for a more aggressive measure. In separate news, China's trade surplus rebounded in April from the previous month's slump. This news, combined with the budget deficit data released earlier this week, which I believe indicated the trade surplus with the U.S. actually narrowed, shows that China's global export market opportunities are expanding.
• *** Oil is being supported this morning by news of a Total platform fire in the Congo, and a recurring theme from the IEA, which again expressed concerns about the tight supply of oil.

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