Today's Coffee - Ironically Late Leading Indicators

The market interpreted Thursday's Leading Indicator data as a positive sign for the economy, and despite a slight uptick in yields, stocks of the major U.S. indices rose Thursday. Wall Street Greek believes the components of the leading indicator data are ironically late, and newer data exists that should have economists and strategists looking beyond Q2. Within this article, we discuss in depth how consumer softness is manifesting in the reports of consumer discretionary shares including restaurants and retailers.

ECONOMIC DATA & ANALYSIS

Late Leading Indicators
May Leading Economic Indicators were reported up 0.3%, in line with expectations as compiled by Bloomberg. The measure is being reported as a positive sign for the economy, and Q2 GDP forecasts that exceed Q1 are finding the limelight. In this week's copy of "The Greek's Week Ahead - The Father of the Next Recession," regarding leading indicators, we said, "April showed a decline of 0.5%, but we also expect an increase in the May data. May was not a relatively poor month on the whole, and the indicators should reflect a positive forward outlook as a result, however false we expect this to prove out."

Some of the component indicators that were reported as providing positive contribution to May, but have weakened in impact for June include the contribution of the stock market, consumer sentiment and decreased jobless claims. Jobless claims have actually held up relatively well in June until this week, which we will get into later. Still, as you can see, leading indicators is missing some new information, quite ironically.

Weekly Initial Jobless Claims
Claims climbed to 324,000 last week, from 314,000 a week prior, and marked their highest level in two months. Leading the charge, California, the same state where foreclosures are greatest in number. Looks like the Governator has a challenge ahead of him.

The level of claims is not as concerning to me as the potential realization of a trend I've been expecting. If claims rate higher than the four-week average of 314,500 again next week, economists and strategists will begin to take notice. Remember, I said consumer softness would show its hand first, and then hiring would slow, which would be followed by increased layoffs and further weak spending. Finally, the anticipation is that manufacturing will also slow and the economy could slip into recession. Later in this article, I discuss the newest signs of consumer softness showing up in the restaurant sector.

Philly Fed
In the weekly article, I alluded that the strength in the New York region provided a guide into Philly's manufacturing sector report released today. Too bad you couldn't bet on it, because Philly blew out the number. The Philly Fed General Economic Index measured 18, versus 4.2 last month. Wall Street Greek's argument regarding the strength in manufacturing is that it will lag the service sector lower, as the sector benefits from dollar weakness in its international sales. Eventually, American demand softness should impact even manufacturers here though.

COMPANY SPECIFIC NEWS

Consumer Softness Signs in the Restaurant Sector
Months ago we wrote that softer consumer spending would eventually expose the oversaturated retail and restaurant industries. We posited that a weakening retail environment would send the Gap's (GPS) of the world into bankruptcy, and even some modest performers into consolidation mode. We also stated that the commercial real estate market had peaked, and would soon join residential real estate in the doldrums. Were you listening? We hope you will remember this six months from now when it is apparent to everyone. Hey, these are just more ballsy views from your favorite independent resource who has no corporate bullcrap to fight through to get his opinion across. Oh, and we are still recommending under-weighting the consumer discretionary sector (read, look for short opportunities here).

This week, Darden Restaurants (DRI), a major player in the casual dining space, displayed one of the early signals we mentioned. Darden reported a fourth quarter loss on charges it took to shut down its newer concepts. Relying on mainstays The Olive Garden and Red Lobster, the cash cow hopes to survive what is described by industry analysts as a challenging environment for the casual dining sector. Like we said, the cost of driving to a restaurant, and increased food expenditures and mortgage payments are pressuring the consumer out of eating out. And when she does, she faces hiked menu prices as restaurants, perhaps less than perfectly hedged against rising food prices, must either bear the margin pressure or transfer the burden to a consumer less inclined to pay it. The industry consolidation we spoke of manifested itself quickly in the well-managed Darden, but other chains will try to overcome the environment and go bankrupt, in my view.

Sonic Corp. (SONC) also reported earnings on Wednesday, and yet another disappointment. Sonic also discussed rising margin pressures, and provided forward guidance for its fiscal fourth quarter below consensus estimates. Not good.

And what about poor Best Buy (BBY) and Circuit City (CC), companies that couldn't receive the Apple IPhone soon enough. Consumer softness is manifesting its ugly head in electronics as well. Circuit City reported a loss and withdrew FY 08 guidance, never a good sign. Electronics retailers may prove worth purchasing on weakness though, as the IPhone draws some consumers into the shop. Still, I think I would rather wait until the criticism of the IPhone hits after its release, and instead buy AAPL on the weakness that likely ensues.

In any event, our view is negative on consumer discretionary as a whole and commercial real estate, where the weakness has likely yet to manifest itself in the shares, or those of other industry related participants.

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