Sunday, January 23, 2005

Economic Week in Review

ECRI Weekly Leading Index 133.30 +1.99%

Empire Manufacturing for January fell to 20.08 versus estimates of 25.0 and a reading of 27.07 in December. "It's still at a high level, but it's a deceleration from the healthy pace of late last year," said Elisabeth Denison, an economist at Dresdner Kleinwort Wasserstein. The New York Fed said the index reading of 20.8 "remained staunchly positive." A government report last week showed that US exports fell late last year, suggesting lagging growth overseas may also be hurting demand for factory goods, Bloomberg reported. The measure of prices manufacturers paid for materials dropped to 50.4 from 57.7. The index of what factories expect to pay six months from now fell to 55.5 from 62.5, Bloomberg said.

Net Foreign Security Purchases for November rose to $81.0B versus estimates of $58.5B and $48.3B in October. International investors accumulated US assets in November at the fastest pace since June and added to stock holdings by the most in 3 ½ years and seven times the average of the previous 12 months, Bloomberg reported. This report suggests that "in the short-term, the US has not had any problem financing its record wide trade imbalance," said Joseph LaVorgna, chief US fixed income economist at Deutsche Bank. "What we're seeing is a return to US equity investments by foreigners, which is the best way to address the current account deficit," said Drew Matus, senior economist at Lehman Brothers.

The NAHB Housing Index for January fell to 70 versus estimates of 70 and a reading of 71 in December. Job and income growth will help fuel sales and limit the restraining effects of higher mortgage rates this year, the builders group said. Home sale are forecast to be the second-highest on record in 2005, according to forecasts from Freddie Mac and the National Association of Realtors. "Builders are geared up for another solid year and expect the demand from home buyers to remain resilient," said David Wilson, president of the NAHB.

The Consumer Price Index for December fell .1% versus estimates of no gain and a rise of .2% in November. The CPI Ex Food & Energy for December rose .2% versus estimates of a .2% increase and a .2% gain in November. Americans paid 2.2% more last year for goods and services, excluding energy and food, below the 2.8% average increase of the last 14 years, Bloomberg said. "It's still a challenging market for a lot of companies to raise consumer prices," said Nariman Behravesh, chief economist at Global Insight. The Fed "can feel pretty good" about the pace of inflation, he said. Workers' weekly earnings adjusted for inflation rose .5% in December, the most in five months, the Labor Department said. The CPI is projected to rise 2.5% this year, below the long-term average of 3.0%, Bloomberg reported.

Housing Starts for December rose to 2004K, the biggest increase in more than 7 years, versus estimates of 1903K and 1807K in November. Building Permits for December fell to 2021K versus estimates of 1985K and 2028K in November. US home construction rebounded in December to cap the best year since 1978 as cheap mortgages and increased employment buoyed demand, Bloomberg said. The Midwest saw the strongest gains, rising 18.8%. "The long-term health of the housing market looks good," said Larry Sorsby, CFO of Hovnanian. "As the economy continues to improve, people that were fearful of losing their job or not finding one are going to be in the housing market, even if interest rates go up modestly."

Initial Jobless Claims fell to 319K, the biggest decline in three years, versus estimates of 345K and 367K the prior week. Continuing Claims rose to 2694K versus estimates of 2675K and 2647K prior. "You are going to get 150,000 to 200,000 jobs a month," said John Silvia, chief economist at Wachovia. "You are in a very stable period for employment." The US economy is likely to grow 3.5% to 4% this year, employment may grow in the range of 150,000 to 200,000 a month and prices will be "relatively stable," Philadelphia Fed President Anthony Santomero said. "As this expansion continues, we will not only see sustained growth in the number of jobs, but also an increase in the proportion of high-paying jobs as well," Santomero said.

The US economy expanded from late November through early January, with most of the 12 Federal Reserve districts reporting only "modest" inflation pressures, the Fed's Beige Book report said. Consumer spending increased in most districts, getting off to a slow start and then picking up after Christmas, according to the survey. The beige book mentioned in several sections that inflationary pressures were modest, Bloomberg said. "Inflation is likely to remain well under control," Fed Governor Bernanke told a gathering at the Council on Foreign Relations. The survey also said the residential real estate market remained strong and commercial real estate strengthened.

The Leading Indicators for December rose .2% versus estimates of a .2% increase and a .3% gain in November. "There's a great deal of optimism about the first six to nine months of 2005," said Will Zardrozny, CEO of Siemens Financial Services. The index of coincident indicators, a gauge of current economic activity, rose .3% in December after increasing .2% the month before, Bloomberg said.

The Philadelphia Fed. Index for January fell to 13.2 versus estimates of 25.0 and a reading of 25.4 in December. Manufacturers may be hard-pressed to sustain last year's growth in industrial production, the most in four years, economists said. "The expansion rate has been too high in recent quarters to be maintained and companies are revising their business plans downward in anticipation of slower growth," said Andreas Busch, senior economist at Bantleon Bank AG. The drop in the Philly and New York indices suggests there will be a decline in the ISM's manufacturing index on Feb. 1, Bloomberg said. A gauge measuring current manufacturing employment rose to 17 from 14 in December. Finally, the prices paid measure rose to 66.1 versus 53.8 in December, Bloomberg reported.

The preliminary Univ. of Mich. Consumer Confidence reading for January fell to 95.8 versus estimates of 97.5 and a reading of 97.1 in December. Lower stock values and a rebound in the price of crude oil "may have dampened sentiment a bit," said Michael Englund, chief economist at Action Economics. "Current levels of sentiment are still solid, and such strength has tended to correspond with solid rates of consumption growth," he said. The current index, which reflects Americans' perception of their financial situation and whether it's a good time to buy big-ticket items, rose to 110.4, the highest since December 2000, Bloomberg reported. "If you just look at what consumers do, what you are seeing is that they came through the holiday season feeling good about what they have spent," Fed Governor Susan Bies said. Citigroup, the world's biggest financial services company, is witnessing "what we view to be very responsible consumer behavior," said CFO Sallie Krawcheck, noting that payment rates on credit cards are moving toward all-time highs. "On average, consumer balance sheets are in pretty goods shape," said Gary Stern, president of the Federal Reserve Bank of Minneapolis.

Bottom Line: Overall, last week's economic data were modestly positive. Measures of manufacturing activity are decelerating from last year's exceptional levels. As of now, I believe manufacturing is just moving to slower more sustainable levels, rather than entering a serious decline. The large increase in foreign purchases of US assets is a big positive considering the weakness in the US dollar, political concerns and deficit worries. The large drop in housing starts in November was a result of the 6th wettest November on record and led to the sharp increase in December. The housing market is very strong and stable in most parts of the country and should remain so for the foreseeable future. Inflation remains below historic norms by most measures and should decelerate this year as commodity prices rise at a slower pace or fall and unit labor costs remain in check. The sharp drop in jobless claims is a positive, however seasonality is likely resulting in abnormally high volatility in this reading. I continue to expect job creation that is good enough to hold the unemployment rate down, but not enough to boost unit labor costs which would spur an acceleration of inflation. The tone of Fed comments this week was less hawkish than previous weeks and may signal they are contemplating a pause in rate hikes. A slowing of the pace of rate hikes is warranted in my opinion and would likely send stock prices higher. Consumer confidence was hurt by increased violence in Iraq ahead of their elections, domestic terrorism worries, rising energy prices and falling stock prices. I expect consumer sentiment to weaken modestly from current levels before turning up again during the second quarter. Before year-end, consumer sentiment should reach new highs for this cycle. The ECRI Weekly Leading Index experienced one of the sharpest rebounds in recent years, rising from 130.70 to 133.30 in one week. The recent declines in this index had been a concern for me.

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