November 22, 2009 – “The Dimensions of Weakness in the Recovery”
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The Dimensions of Weakness in the Recovery
We have been characterizing the pace of this fledgling economic recovery as underwhelming. We have also characterized the durability of the recovery itself as fragile. Last week’s economic indicators and the behavior of the financial markets very much amplified these sentiments. Housing starts in October declined 10.6% to 529,000 units, well below market consensus expectations of 599,000. Housing starts are down 30.7% y/y. Some of the explanation may lie in a colder and much wetter October than normal, not incorporated in the seasonal factors. Building permits dropped 4% in October, disappointing market consensus expectations of a small increase from September.
Adding to market angst and fueling fears of a double-dip in housing, the National Association of Home Builders (NAHB)/Wells Fargo housing market index (HMI) fell to 17, below market expectations of 19, which would have been a rise from 18 in October. The October level of 17 is the weakest since July ’09. Builder pessimism is driven by difficulty obtaining credit for new construction, and by losing sales due to very low appraisal values. This pessimism is specifically related to foreclosed and distressed properties being used in “comps”. The worsening of builder pessimism is at first troubling in that Congress voted to extend the homebuyer tax credit on November 5th. The NAHB, however, said it received the majority of responses for the November survey prior to November 5 when Congress acted to extend the homebuyer incentive, signed by President Obama on November 6th. We expect the extended homebuyer tax credit will generate a much better December reading in the HMI.
Another caution in the housing outlook is that the Federal Housing Administration (FHA) has seen its capital reserve fund plummet to $3.6 billion at the end of the 3rd quarter, down 72% y/y. Also, the mortgage purchase application index last week hit its lowest level in 12 years. This will recover somewhat due to the homebuyer tax credit extension. Let us also not forget that unsold housing inventories have declined and that pricing has modestly improved.
Turning to the manufacturing sector, the NY Fed’s Empire Manufacturing detail showed a pullback in its General Business Conditions Index to 23.5 in November from 34.6 in October. Market consensus expectations saw a pullback to 29.0 in November. The actual result was significantly worse than expectations, but we remind our readers that the 34.6 reading in October was the 4th successive monthly rise and the highest level in five years.
Unlike the NY Fed measure, the Philadelphia Fed’s General Business Activity Index rose 5.2 points in November to 16.7, better than market consensus expectations of a November level of 12.0, essentially flat with the October level of 11.5. The Philadelphia news was not all positive. Its 6-month forward futures index faltered again in November, underscoring the risks to the manufacturing sector in the first half of 2010.
Industrial output edged higher by only 0.1% in October, below market expectations of a 0.4% increase. Manufacturing output slipped 0.1% in October, following three straight months of gains. Mining output fell 0.2% in October, while utility output advanced 1.6%. Capacity utilization for total industry edged higher to 70.7 in October, a bit below consensus expectations of 70.8. Capacity utilization in manufacturing was flat in October, after two months of increases.
In sharp contrast to the weakness in the indicators above, October retail sales rose 1.4%, beating consensus expectations of a 0.9% advance. While autos provided most of the vigor in the October retail sales data, retail sales have risen at a 6% annual rate over the three months ending in October, whether autos are excluded or included. And, “core” retail sales (excluding autos, gasoline, and building materials) increased 0.5% in October. The ABC News Consumer Comfort Index improved to -45 in the week ending November 15th. While not a level implying great levels of strength, it was the best reading since early October.
The overall index of leading economic indicators (LEI) rose 0.3% in October, the 7th consecutive monthly rise, but also the smallest gain since the LEI turned positive. The ratio of coincident to lagging indicators was almost flat, raising the concern of a diminished momentum in the recovery.
In the latest inflation readings, the October producer price index (PPI) showed lower than expected numbers. The overall PPI increased by a less than expected 0.3%, while the core PPI, ex food and energy, plunged 0.6%. The consensus expected a 0.1% rise. The overall PPI is still deflating 1.9% y/y, and the core has been steadily slowing to a y/y rise of just 0.7%.
The October CPI rose 0.3%, a touch higher than the 0.2% expected increase, while the core CPI rose 0.2%, higher than the consensus call of 0.1%. The surprise in the CPI data was due to a 1.7% rise in the vehicle component area, as a rebound in new vehicle prices followed the end of the “Cash for Clunkers” program. The overall CPI is still down 0.2% y/y, while the core CPI is at a subdued 1.7% y/y.
Fed Chairman Ben Bernanke has reiterated concerns about the economy being “likely to warrant exceptionally low levels of the federal funds rate for an extended period.” The debate within the Fed is best exemplified by Richmond Fed President, Jeffrey Lacker, who has expressed concern that the Fed needs to be more proactive in moving interest rate higher to fend off rising inflation in the futures. We disagree with Lacker, given deflationary risks.
While deflation remains a clear and present danger, the excessive and growing federal budget deficit causes a real threat of higher long-term interest rates. In our view, this threat is amplified by Bernanke’s intention of keeping the federal funds rate near zero beyond the middle of 2010.
There is a far better form of fiscal stimulus than anything we’ve thus far seen. And, it would more quickly stimulate employment. Policymakers should be cutting payroll taxes. Ronald Reagan is alive and well in the personage of German Chancellor Angela Merkel, who feels tax reduction is a must in generating healthier economic growth.
Economic Indicators in the Week Ahead:
Monday, Nov. 23 8:30 a.m. Chicago Fed National Activity Index
We see this measure increasing to positive territory.
Monday, November 23 8:30a.m. October Existing Home Sales
We believe existing home sales will rise 3% in October to 5.74 million units annualized from the 5.57 million units in September. The consensus sees a 2.3% gain in October to 5.7 million units. Our projection is based in part on very strong pending home sales data in September. The extension of the home buyer tax credit is a big plus as well.
Tuesday, November 24 8:30a.m. 3rd quarter Real GDP Revision
The “Advance” report showed 3Q:’09 real GDP rising 3.5% annualized. We expect a downward revision in the Bureau of Economic Analysis (BEA) “preliminary” estimate to a real GDP growth rate of 2.7%. The lower growth rate is due to weaker nonresidential fixed investment, and a wider net export deficit.
Tuesday, Nov. 24 9:00a.m. September Case-Shiller Home Price Index
We expect the CS price index for the 20 largest cities to increase 0.6% m/m, the 5th straight such advance. The y/y decline should drop to 9.1%. The market consensus sees a 9.2% y/y decline.
Tuesday, Nov. 24 10:00a.m. November Consumer Confidence
The Conference Board series should rise to 48.0 from 47.7 in October. The consensus has a 47.0 expectation.
Wednesday, November 25 8:30a.m. October Durable Goods Orders
We project a 0.7% rise in October durable goods orders, a slowing from the 1.4% rise in September, but stronger than the consensus view of a 0.5% rise. Slower private aircraft orders are central to the slower gain than that of September.
Wednesday, Nov. 25 8:30a.m. Oct. Personal Income and Spending
We anticipate a 0.1% gain in personal income in October, in line with the consensus. Private sector wages and salaries, we believe, were flat in October. Personal consumption expenditures (PCE) likely rose 0.6%, higher than consensus which expects a 0.5% gain in nominal PCE. In our estimation, the personal savings rate falls to 2.8% in October, from 3.3% in September.
Wednesday, November 25 8:30a.m. Initial Jobless Claims
We see initial jobless claims for the week ending November 21st going below the 500,000 level to 475K, the lowest initial claims level since October 2008. This is lower (better) than the consensus call of 500K.
Wednesday, November 25 10:00a.m. October New Home Sales
We expect new home sales to rise slightly to 405,000 units annualized, marginally higher than the 402K level of September, but below the consensus call of 410,000 units annualized.
Wednesday November 25 10:00a.m. Nov. Consumer Sentiment
We see the final Reuters/University of Michigan Index of Consumer Sentiment rising to 68.0 in November, from the November preliminary reading of 66.0, but still below the 70.6 level of October. The consensus sees the final November reading at 67.0.
Jack W. Lavery
CEO & Chief Economist of Lavery Consulting Group, Senior Executive Fellow in Financial Economics at the University of Maine