Beyond the Lede: Playing the Economic Data

• ByDavid Sterman, RealMoney Contributor
• On 2:30 pm EDT, Monday May 11, 2009

We got a mixed bag last week with regard to economic data. On the positive side, monthly unemployment claims appeared to show signs of moderating; we lost fewer than 600,000 jobs for the first time since last autumn. On the other hand, inventories are not falling fast enough to bring down the pile of unsold goods. But as sales stabilize during these summer months, continued inventory destocking should take us to lean levels -- and the beginning of an inventory rebuilding cycle.

Seizing on the employment data, UBS has boosted its view of staffing stocks, raising target prices for On Assignment , Robert Half and Manpower . These firms derive much of their sales from placing temps with employers, and temps are the first component of labor to be added when companies are keen to boost the workforce but loath to commit to a permanent rise in expenses.

Notably, UBS believes the executive recruiters are not the way to go. Firms Korn/Ferry and Heidrick & Struggles could see very weak demand for quite some time.

UBS assumes that domestic unemployment will most likely peak at 10.5%. Although that rate has risen by either 40 or 50 basis points in each of the last five months, wide-ranging commentary from the just-concluded large-cap earnings season implies that many companies have completed their downsizing process, and further layoffs are only likely to come from bankruptcy declarations.

Moreover, the recently rising stock market has enabled debt-distressed companies to start looking at raising fresh capital, and the longer the market stays aloft, the smaller the chance that we'll see the heavy slate of bankruptcies that were anticipated just a few months ago. So although UBS is likely correct that unemployment will top out above the 10% mark, fears of far higher unemployment peaks are steadily receding.

Whittling Down the Goods

If you live near a major U.S. port, you're bound to encounter huge lots of unsold cars. Even though global automakers sharply cut back output this winter, weak sales kept the unsold pile of cars and trucks at stubbornly high levels. That theme has played out in a wide range of industries lately.

But retail inventories, which have steadily increased as a segment of the economy over the last 30 years (according to the Department of Commerce), are quickly working down to reasonable levels. The retail inventories-to-sales ratio peaked at 1.38 in December and has fallen back 1.33, just above the 2007 average of 1.32. If the ratio keeps falling, perhaps to around 1.30, retail inventories may resume a pace in line with end sales, which would pull all those unsold wholesale inventories into the system.

That's why a pair of economic data points this week loom large: On Tuesday, we'll get the reading for retail sales in April, which likely fell around 0.1%, according to consensus forecasts. The next day, we'll get a read on business inventories, which likely fell -1.1% in March. (Note that the two readings are out of sync by one month.) As inventories fall faster than sales, we move closer to the end of this destocking process.

Any rebuilding inventories would be great news for shippers such as UPS and FedEx . Analysts expect UPS to post a 5.6% rebound in 2010 sales (which would still be below levels posted in 2008). FedEx, which has a fiscal year that ends in May, is expected to post a 3% drop in fiscal 2010 sales, but would presumably see a similar bump in its fiscal 2011 numbers. Both of these stocks have erased earlier losses and are back to levels seen at the start of the year. That said, these stocks are not cheap (based on the 2010 view), and if the inventory rebuilding cycle doesn't play out according to plan, these shares could quickly move back to their March lows.

Fixing the Rig Count

Throughout the winter, the number of oil and gas rigs in service has been steadily dropping, but that process appears to be winding down. At the end of March, 1,105 oil and gas rigs were in service in the U.S., according to Baker Hughes , down from 1,797 a year earlier. But over the last five weeks, the rig reduction has been steadily abating. In the last five weeks, the rig count has fallen 38, 30, 20 and 10 before a modest uptick of 17 last week. That last reading could be a final capitulation, reflective of decisions made when natural gas prices plumbed new lows in mid-March. Now energy prices are starting to firm, and marginal rigs that were on the bubble might stay in service after all.

We'll likely now see all those rig count cuts translate into falling output within a month or two. As output falls, confidence will increase that the current glut (especially of natural gas) will abate, and the stage would be set for further price gains for these commodities -- assuming global GDP growth is back in the black in 2010.

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider On Assignment, Korn/Ferry and Heidrick & Struggles to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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