McDonald’s Earnings: What They Tell Us
about U.S. Consumer Spending Patterns

The earnings results for McDonald's are a good indication of what's going on with the  regular consumer. What are the fourth-quarter earnings telling us?This morning comes news that McDonald’s Corporation (NYSE/MCD) same-store sales rose five percent in its latest quarter. While General Electric Company (NYSE/GE) is the bellwether stock I follow for indications on where the economy in general is headed, I follow McDonald’s stock to see how the majority of consumers are faring.

We all know that high-end consumers are back spending. Just look at the charts of Coach, Inc. (NYSE/COH) or Tiffany & Co. (NYSE/TIF) and you’ll see that luxury items such as big-ticket purses and jewelry are selling quite well. But how about the regular folk; how are they faring at an unemployment rate of close to 10%?

McDonald’s stock basically tells the story: Consumers are slowly spending more. A five-percent increase in sales at McDonald’s is quite representative (for me) of the largest consumer segment; they are opening their wallets slowly, but nonetheless opening them.

Consumer spending in the U.S. makes up between 60% and 70% of the economy. Hence, how these consumers spend is very important. We knew the higher-end market was coming back, but how about the rest of America? McDonald’s same-store sales tell us that the broader-based consumer market is opening up.

But, while I hate to be the bearer of bad news, I don’t expect consumers to give corporate American wide-open wallets anytime soon. By late spring or early summer of 2011, consumers will be quite aware of rising inflation and rising interest rates and that will place a damper on their spending habits.

McDonald’s fourth-quarter earnings came in at $1.24 billion, up from $1.22 billion in the same period of 2009. We’ll have a slew of earnings reports coming in from companies this week. As most will reflect the fourth quarter of 2010 and full 2010 earnings, I expect the majority of earnings reports to be strong.

Michael’s Personal Notes:

Since I wrote last week about the mounting pressure on municipalities to file for bankruptcies and for states to default on their debt obligations, I have received a slew of e-mails from readers asking for more specifics on this situation. Here they are:

The biggest budget shortfalls are for these states, followed by their dollar shortfall for this year: California ($25.0-billion shortfall), Texas ($14.0-billion shortfall), Illinois ($15.0-billion shortfall) and New Jersey ($11.0-billion shortfall). According to The New York Times (1/23/11), 44 states will have budget shortfalls this year.

In respect to the municipalities, investors in the municipal bond market pulled out a record $20.6 billion in the period from November 17, 2010, to January 19, 2011, according to Denver-based Lipper U.S. Fund Flows.

Looking back through history, during the 1930s, 14% of counties and nine percent of municipalities in the U.S. defaulted on their debt. Arkansas was the only state to default on its debt during the Great Depression.

The yield on a 30-year, triple-A-rated municipal bond sits at 5.12% this morning; its highest level in two years. Investors in the municipal bond market are running scared; they are pulling money out of that market and yields are rising sharply.

Do I believe cities and municipalities will be filing for bankruptcy this year? Definitely, and I don’t think the federal government will bail out either cities or municipalities. I don’t see any states going bankrupt for the simple reason that there is no legal means for them to file for bankruptcy. But I do see states defaulting on their debt. Are many states not in default already because they are sitting on bills they cannot pay?

What does this all point to? As I have been writing for months, higher interest rates lie ahead. (On a side note, Hungary has become the latest country to raise interest rates. The country’s central bank raised its benchmark rate 25 basis points this morning to six percent.)

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average opens this week up 2.5% for 2011 and only 128 points away from Dow Jones 12,000.

My opinion on the market remains unchanged: in the immediate term, the bear market rally that started in March of 2009 has more (but limited) upside potential. For the short to long term, I’m turning bearish on stocks for two reasons: too much optimism among investors and stock analysts; and mounting pressure on interest rates to rise.

What He Said:

“What group of stocks are next to fall in light of the softening U.S. housing market? The stocks of companies that sell retail products to the American consumer, I believe, are next on the hit list. Many retail stocks are already reporting soft sales. In my opinion, they haven’t seen anything yet in respect to weaker sales.” Michael Lombardi in PROFIT CONFIDENTIAL, August 30, 2006. According to the Dow Jones Retail Index, retail stocks fell 42% from the fall of 2006 through March 2009.