Sunday, December 19, 2010

US Review: Economic Recovery is Gaining Momentum

Economic Recovery is Gaining Momentum 
Developments in the economy this week were generally better
than expected and served to underpin our long-held view of slow
growth while simultaneously diminishing the credibility of the
double-dip crowd.

We raised eyebrows a few weeks ago with our upbeat holiday
sales outlook. This week’s stronger-than-expected retail sales
report for the month of November suggests that our forecast for a
5.0 percent year-to-year increase  in holiday sales should be on
track. Some of the strongest monthly gains were seen in sectors
associated with holiday shopping  like department stores, general
merchandise stores, and, of course, clothing stores.

Strength was not limited to consumer spending. We also learned
this week that industrial production rose 0.4 percent in
November with gains spread across many sectors including
consumer appliances, business equipment, construction supplies
and materials. Outside of motor vehicles, output was even
stronger, up 0.7 percent on the month. This strength is consistent
with our expectation for continued growth in business investment
as a support for continued growth, as we recently expressed in
our Annual Outlook for 2011.

Speaking of the manufacturing sector, various regional surveys
released this week provided a more encouraging view of industry,
at least in some parts of the country. In the New York area, for
example, the Empire Index from the NY Federal Reserve bested
the consensus forecast with gains in new orders and shipments.
One hundred miles to the south, the Philadelphia Federal Reserve
also reported a gain of roughly two-points in the Philly Fed Index.
While the gain was rather modest, the consensus had expected a
decline to a level of 15. The details of the report also revealed a
faster pace of growth in orders and unfilled orders. Also worth
noting in these surveys was the continued pricing pressure for
manufacturers. This pressure shows up in the surveys in the
“prices paid” measure which jumped in both the Empire and the
Philly Fed measures.

The concern about rising prices for manufacturers is that it can be
difficult for businesses to pass on those price increases to
consumers when unemployment is still high and consumers are
discerning about their spending habits. When producers cannot
pass on price increases, it comes out of the corporation’s profits.
In addition to what purchasing managers tell us in surveys,
“hard” price data do indeed appear to be rising at a fairly steady
clip. The producer price index jumped 0.8 percent in November.

Prices further back in the pipeline also increased with
intermediate goods up 1.1 percent and crude goods up 0.6
percent. However at this stage in the economic cycle, the
increases in wholesale prices have yet to show up in consumer
prices. Indeed, the consumer price index (CPI) for November
increased a mere 0.1 percent and core prices were also up 0.1
percent. On a year-over-year basis, the CPI is up only 1.1 percent.
We  do  not  look  for  much  of  a  pick  up  in  consumer  inflation
anytime soon—a factor that may weigh on corporate profits.

Existing Home Sales • Wednesday 
Existing home sales fell 2.2 percent to a 4.43 million unit seasonally
adjusted annual rate in October. Single-family homes dropped 2.0
percent, while multifamily homes slid 3.6 percent. Despite recordlow mortgage rates, sales have been extremely weak amid high
unemployment, tight credit, underwater mortgages and fear of
further price declines. Adding salt to the wound lately has been the
foreclosure signing issue. The supply of homes for sale fell to 3.86
million in October, but the weak sales pace kept the inventory/sales
ratio at a still-high 10.5 months. Following the expiration of the tax
credit, the median sales price has plunged again from $183,000 in
June to $170,500 in October. We expect all of the above factors to
continue weighing on sales in the months ahead. However,
November sales may have gotten a boost from the resumption of
some foreclosure sales. Recent increases in mortgage rates are yet
another headwind, but could prompt some fence-sitters to act.
Previous: 4.43M  Wells Fargo: 4.65M
Consensus: 4.75M

Durable Goods Orders • Thursday 
Durable goods orders fell 3.3 percent in October following a strong
September reading that was driven by a surge in non-defense
aircraft orders. In October, all major categories saw declines, led by
computers and electronics. Non-defense capital goods, excluding
aircraft, a proxy for future business investment, slid 4.5 percent. In
addition, the inventory/sales ratio  climbed to 1.61, the highest in
over a year and on par with levels seen during the 2001 recession.

This suggests production could slow in the months ahead as
inventory replenishment slows. However, recent economic data
show that the economy has picked up a bit. This, along with the
volatile nature of this indicator, suggests we should see a better
reading in November. Emerging market strength, along with
replacement of aging equipment and capacity expansion, could
support orders despite the rising inventory/sales ratio.

Previous: -3.4%  Wells Fargo: 1.9%
Consensus: -0.6%

Personal Spending and Income • Thursday 
Personal spending rose 0.4 percent in October, slightly less than
expected but slightly better than September’s pace. Personal
income rose 0.5 percent following no change in September. Wages
and salaries rose 0.6 percent, the most since May, as employment
jumped by 172,000. Still, core PCE inflation, the Fed’s preferred
measure, was a record-low 0.9 percent. With incomes rising faster
than spending, the savings rate edged up to 5.7 percent. Pent-up
demand, rising incomes, job gains, a stock market rally and builtup savings are all supporting spending during the holiday season.

We expect to see another decent reading for spending in November.
However, income growth may be  tempered a bit by the weak job
gains seen in November. The rebound in the unemployment rate
could give some consumers reason to be cautious, but any
slowdown in spending, if it occurs, will likely not happen until after
the holidays.
Previous: 0.4% Wells Fargo: 0.4%
Consensus: 0.5%
Full report: US Review:  Economic Recovery is Gaining Momentum

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