ANALYSIS/OPINION:
Over the last two weeks investors have received more than a little data on how the domestic economy is performing. At the same time, we are heading deeper into corporate earnings reports for the quarter ending March 31.
Results in some cases are better than expected while others are not. As I mentioned in a previous column, we as investors are looking to stitch together data coherently to confirm or disprove our investment view on an industry or company. What can make this difficult is when the data conflicts, as has happened these last few weeks. The question then becomes a familiar one for people who have been in the stock market - what do I do now?
To answer that question, we have to back up a bit because, as I have mentioned before, a data point in a vacuum does not really tell us much. Rather, we need context in order to properly frame and understand the data as we get them. It’s also important to understand the difference between a leading indicator and a lagging indicator.
A lagging indicator is one that describes what has already happened or as some of us call it “a look in the rear view mirror.” One such lagging indicator in my view is gross domestic product. It is an important yardstick, yes, but it measures economic activity from a prior period. Another such lagging indicator is the monthly nonfarm payroll data (more commonly known as the employment report) released by the Bureau of Labor Statistics, because it discusses what happened in the prior month. In comparison, the Department of Labor releases weekly initial unemployment claims, which many use as a leading indicator for what the nonfarm payroll data will be for the month.
Another example is housing starts and building permit data both of which are released by the Census Bureau. Housing starts measure the number of residential units on which construction has begun each month, which is characterized by the beginning of excavation of the foundation. Building permits are a leading indicator of housing starts because in order for that construction to occur, permits need to be taken out in order to allow excavation.
Corporate earnings to some degree is a lagging indicator, but part of it is also leading. The “lagging” part is that the corporation’s management team describes the company’s performance for the prior quarter. But what makes corporate earnings and the corresponding conference calls potentially “leading” indicators is the management team’s outlook commentary, which discusses the current view on the industry, the company and the competitive position.
Even these outlooks and prognostications by management teams have their own form of leading indicators - all an investor needs to do is look for them. Earlier this week CSX Corp. reported its first-quarter 2009 results and the company’s profit dropped 30 percent as its freight volume fell 17.4 percent due to weak demand for a number of areas, including automotive goods, chemicals and housing-related products.
Was that a surprise or more precisely should that have been a surprise? My answer would be no: not because of the general awareness of current economic conditions but because those rolling up their sleeves and doing their homework on the freight industry would have been tracking weekly freight car loadings. During the first 13 weeks of 2009, U.S. railroads experienced a 16.7 percent decline in total carloads, per the Association of American Railroads.
Another example of weekly data that can be used to gauge how other monthly data is shaping up relates to retail sales.
Retail sales tumbled in March, according to the Commerce Department’s monthly report, and while the data was worse than expected by many, the issue here is could we have seen this coming. I would point to two weekly data series - the International Council of Shopping Centers/UBS Weekly Chain Store Sales Snapshot and the weekly Johnson Redbook Retail Sales.
One area that I am starting to track is gasoline prices, which have started to rise and are expected to rise further as we head into the summer driving season. I plan to keep tabs on those prices by using data from AAA and the U.S. Energy Information Administration. My concern is how rising gas prices will affect disposable income in the coming months; after all, roughly 70 percent of U.S. economic activity is tied to consumer spending.
To answer the question I posed at the start of this article, what we should do now is pull together as many “leading” data points as we can that pertain to those stocks that we own. Once we have them, be they good, bad or ugly, we as investors should listen to what they are suggesting could happen in the coming weeks.
If the results suggest that things have bottomed out or are getting better, then that is a good thing. If however, the data points to a gloomy outlook, much the way the weekly freight carloadings data did then we need to reassess our position and contemplate exiting. This is particularly the case given the strong move we have had in the stock market over the last several weeks. In my opinion, it never hurts to take profits.
• Chris Versace is the founder and portfolio manager of SlipStream Capital Management LLC based in Reston. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in the companies mentioned in his column, although positions may change at any time.
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