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SIMPLY ECONOMICS
Panic drives equities but not econom y
Econoday Simply Economics 5/21/10 By R. Mark Rogers, Senior U.S. Economist

Equities plunged well into correction territory on fears that Europe may be headed back into recession due austerity measures likely to be imposed in Greece and other debt-strapped economies on the continent. But indicator news for the U.S. is more optimistic—though there are signs of moderation in growth.

Recap of US Markets STOCKS

It started as a quiet week with a modest rebound on the first trading day. Investors saw the drop in stocks the prior Friday as oversold. Also, the homebuilders index pointed to optimism for future construction. Despite a strong housing starts number and better-thanexpected sales from retailers on Tuesday, stock took their first major fall for the week on news that Germany was imposing a ban on naked short selling on certain bank stocks and

eurozone bonds. The worry was that regulators knew more bad news about banks but just were not telling. The unexpected and solo move by Germany sharply rattled markets. Equities fell sharply early in the mid-week session on news that a record share of U.S. mortgages were in foreclosure. But an upgrade in the Fed’s quarterly forecast for the economy cut stock losses. Worries about European sovereign debt continued to weigh on stocks. The big drop was on Thursday as U.S. stocks were led down by a selloff in Europe, by an unexpected rise in initial jobless claims, and a dip in the index of leading indicators—even as the Philly Fed index was positive and beat expectations. Also, Japanese economic growth was less than projected by analysts. Equity declines accelerated during the day on technical trading after the S&P fell below its average for the last 200 days. Fear clearly was another factor as calls came in to move into cash. Stocks posted a moderate rebound the last trading day after the Senate passed financial reform legislation. The action had been expected for some time but bank stocks rallied, given that the legislation was not worse than expected from banks’ view. Earlier, on Thursday after close, Dell reported higher quarterly earnings and revenues that beat expectations—helping the tech sector and other indexes. Also, bargain hunters were out in force. Short covering helped to accelerate the rebound prior to close. Nonetheless, it was a bad week for equities. Indexes generally are down more than 10 percent from recent highs seen in April. Some argue that this correction was simply waiting for an excuse to happen. For the U.S., the correction should not translate into a worsening economy. Overall fundamentals have improved significantly in recent months and the recovery should continue. Equities were down sharply this past week. The Dow was down 4.0 percent; the S&P 500, down 4.2 percent; the Nasdaq, down 5.0 percent; and the Russell 2000, down 6.4 percent. For the year-to-date, major indexes are mostly down as follows: the Dow, down 2.3 percent; the S&P 500, down 2.5 percent; and the Nasdaq, down 1.8 percent. The Russell 2000 is up 3.8 percent.

Markets at a Glance

Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.

BONDS

Treasury yields fell sharply again this week. Again, it was nearly all about flight to safety as funds moved out of equities and into U.S. Treasuries. Rates dropped the most on the two days that equities declined their sharpest—Tuesday and Wednesday. Also adding to rate weakness were very low PPI and CPI numbers out during the week and a bump up in initial jobless claims. Even though at mid-week the Fed upgraded its forecast for GDP, it lowered its inflation forecast and this added to rate softness.

For this past week Treasury rates were mostly down as follows: the 2-year note, down 3 basis points; the 5-year note, down 13 basis points; the 7-year note, down 20 basis points; the 10-year bond, down 22 basis points; and the 30-year bond, down 24 basis points. The 3-month T-bill was unchanged.

The Treasury yield curve has flattened substantially over the last few months. Since the end of 2009, the long-bond yield has dropped 54 basis points while the 3-month T-bill has firmed by 10 basis points. Basically, inflation expectations have eased despite looming federal deficits. The new attractiveness of the dollar as a safe haven in light of the euro’s current woes also has helped lower rates. Yields of notes also have eased since the end of 2009—as indicated by a 38 basis point decline in the two-year T-note rate and 66 basis point dip for the five-year.

OIL PRICES

While equities have been hit hard, many commodities—including oil—have taken an even bigger hit. The S&P 500 has fallen 10.6 percent since a recent high seen in late April. In contrast, the spot price for West Texas Intermediate settled at $68.04 on Friday, compared to a recent high of $85.84 on April 30. WTI has fallen a whopping 21 percent. Weakness in the euro has contributed to oil’s demise—even though the euro actually ended this past week up a bit. The real worry, however, is that economic growth is going to slow due to austerity measures in Europe and due to tightening by China of its credit markets. Net for the week, spot prices for West Texas Intermediate fell $3.14 per barrel to settle at $68.04. Other commodities also were under downward pressure. The RJ/CRB commodity futures index fell 2.8 percent this past week and is down 10 percent from a recent high in mid-April.

The Economy
Economic news was net positive this past week with housing starts healthy and continued gains in manufacturing. But housing permits declined as did the index of leading indicators.

Gain in housing starts tempered by drop in permits

The extension and expansion of homebuyer tax credits for fiscal stimulus appears to have had the intended effect. You can argue over the degree of cost effectiveness of various stimulus programs but you cannot deny that home sales jumped for the initial homebuyer tax credit program last fall and again this spring. Yes, tax credits work. As a result, a big portion of the overhang in homes on the market has been worked down as indicated by

months’ supply numbers. And homebuilders have had the luxury of actually building new homes—though still at a low level of activity. With the expiration of the special tax credits, we are likely at a temporary turning point in housing as sales will likely slow over the next few months, as indicated by the latest housing starts report.

But for now, homebuilders have benefited from the jump in sales. Housing starts in April advanced 5.8 percent, following a 5.0 percent gain in March. The April annualized pace of 0.672 million units was up 40.9 percent on a year-ago basis. April’s gain was led by a 10.2 percent increase in single-family starts, following a 2.1 percent rise in March. The multifamily component fell 18.6 percent after a 24.4 percent surge the month before. But given the expiration of special tax credits in April, homebuilders are not rushing to the courthouse to pay for new building permits and are actually dialing back a bit. Housing permits declined 11.5 percent, following a 5.4 percent boost in March. Basically, homebuilders boosted construction in the wake of the sales spike. But they are now cautious about near-term sales. They cannot afford a rise in speculative inventories that may not sell. But if employment continues to rise, the softening in housing will be temporary.

Philly Fed and Empire State—moderation ahead for manufacturing?

Manufacturing is still a key engine to the recovery’s growth. But there are signs that the upward pace may soften in the near term.

The Philadelphia Fed's general business conditions index edged higher to 21.4 in May from April's 20.2. However, the new orders index slipped to 6.1 from the 13.9 reading in April. The positive number still indicates growth in orders but at a less rapid pace than in April. But the impact of slower growth in orders may be softened by a drop in inventories due to a boost in shipments. Manufacturers will want to keep inventories at a reasonable level and some rebuilding may be needed.

The Empire State manufacturing survey showed a similar pattern as general business conditions were strong while new orders moderated. The Empire State general business conditions index for May came in at 19.11, well above break-even zero to signal significant growth compared to April. The April index was 31.86, to indicate vast acceleration from March. Nonetheless, the May figure is still relatively high, indicating significant growth—just not as rapid as April. But the new orders index came in at 14.3—down from April's 29.49. The latest figure is still positive, indicating growth but moderating growth. Overall, manufacturing continues on an uptrend in the second quarter but the pace of growth may be moderating. This should not be unexpected as it is typical that manufacturing rebound robustly during initial recovery and then ease to a more sustainable pace thereafter.

CPI inflation drops away

Despite continued ease by the Fed, inflation is almost nonexistent. In April, overall CPI inflation dipped 0.1 percent after edging up to 0.1 percent the month before. Core CPI inflation was flat for two months in a row. At the headline level, a drop in energy prices weighed on costs while food was still moderately strong. The core was kept low by extremely soft shelter costs along with a decline in apparel.

The U.S. economy clearly is on a disinflation trend—that is, a slowing in inflation, not an outright decline (despite a monthly dip for April). Year-on-year, due to weaker energy costs overall CPI inflation eased to 2.2 percent (seasonally adjusted) from 2.4 percent in March. The latest figure is down from a recent high of 2.8 percent for December 2009. The easing in the core rate has been even more dramatic. The core rate slipped in April to 1.0 percent from 1.2 percent the prior month and is down from a recent high of 1.9 percent for April 2009. However, the longer disinflation trend goes back to the pre-recession high for the core at 2.9 percent in September 2006. The core is well below even the Fed’s lower boundary of its implicit target of 1-1/2 to 2 percent inflation. As such, the Fed has plenty of wiggle room for the timing and how fast the Fed unwinds its balance sheet expansion.

Producer price inflation still tame overall

Inflation is subdued at the producer level also. Overall PPI inflation eased to down 0.1 percent in April from a 0.7 percent spike in March. Declines in both food and energy helped pull the headline figure down. At the core level, the PPI came in with a 0.2 percent increase, following a 0.1 percent uptick in March. The key factor behind the boost in the core was cuts in discounts by auto dealers. The dip in the headline PPI was led by a 0.8 percent decline in energy costs, following a 0.7 percent increase in March. Food prices slipped 0.2 percent on lower prices for fruits and vegetables as the impact of severe winter weather fades. Egg prices also fell significantly. At the core level, the boost was led by a 0.6 percent jump in passenger car prices after declining 1.1 percent in March. This basically reflected on and off discounts by auto dealers.

Leading indicators dip even as current economy strengthens

The Conference Board's report on leading indicators was mixed for April as the leading index slipped but the coincident index strengthened. In April, the index of leading economic indicators posted its first decline in a more than a year, edging down 0.1 percent, following a 1.3 percent surge the month before. The latest number primarily reflected a decline in building permits and shortening delivery times. Unemployment claims and consumer sentiment also weighed on the index. With the recent sharp drop in equities and dip in building permits, we may see another decline in the leading index for May. But after such a long string of strong gains, a modest retreat should be seen a pointing to moderation in growth and not a double dip recession.

Other data in the latest report point to an end to the most recent recession. The index of coincident indicators rose 0.3 percent in April, following a 0.1 percent boost the month before. This index has been on an upward trend since July 2009, suggesting that the recession ended in the middle of last year. Of course, a technical end to recession does not mean the economy is robust yet. Still, growth has been moderate and the recovery has gained traction.

The bottom line
Two sectors of the economy appear headed for near-term moderation. Housing will come off a second round of fiscal stimulus from special tax credits. Manufacturing is still growing but perhaps at a less robust pace according to new orders indexes in regional surveys. But we are talking about a moderation in growth—not a decline. There are few signs of a double dip recession in the U.S. although one could make an argument that the odds are significant for such in Europe. If the U.S. consumer continues to keep its wallet open, the economy remains on track for recovery. And for now, that appears to be the case despite volatility in financial markets.

Looking Ahead: Week of May 24 through 28
The first traditional market moving indicator is durables orders out on Wednesday, followed by a revised estimate for first quarter GDP on Thursday. The week ends with a status report on the consumer with the personal income report. But the existing and new home sales reports on Monday and Wednesday also should garner considerable attention.

Monday
Existing home sales in March rose 6.8 percent to an annual rate of 5.35 million from February’s 5.01 million. Gains were evenly distributed across regions. For the U.S., the year-ago pace improved to 16.1 percent from 6.8 percent in February. Supply fell back to 8.0 months from February's 8.5. First-timers were 44 percent of total sales, up 2 percentage points from February. Because existing home sales are based on closings (instead of contract signings), we may still see a bump up in sales for April as the end of that month was the deadline for closings to qualify for special tax credits for homebuyers. Existing home sales Consensus Forecast for April 10: 5.600 million-unit rate Range: 5.420 to 5.800 million-unit rate

Tuesday
The Conference Board's consumer confidence index in April posted its second consecutive strong gain, rising about 5-1/2 points to 57.9. The gain was led by the expectations subcomponent which jumped 7 points to 77.4, reflecting rising optimism over the outlook for business conditions and easing pessimism on the outlook for employment and income. The assessment of the present situation also improved with the index rising more than 3-1/2 points but to a still severely depressed level of 28.6. But we could see some slippage for May, given the stall in improvement in initial jobless claims and the sharp drop in stock prices. Already, we have seen a stall in the mid-May consumer sentiment index which showed only marginal improvement from April. Consumer confidence Consensus Forecast for May 10: 59.0 Range: 56.0 to 61.0

Wednesday
Durable goods orders in March dipped a revised 1.2 percent after gaining 0.5 percent in February. But the headline number was pulled down by a sharp drop in nondefense aircraft orders—a very volatile series. Excluding the transportation component, however, new durables orders actually spiked a revised 3.7 percent, following a 2.1 percent rebound in

February. The March surge in ex-transportation was the biggest since a 5.3 percent spike in August 2005. Looking ahead, key manufacturing surveys suggest a healthy new orders figure for April. The ISM, Philly Fed, and New York Fed manufacturing surveys showed a strengthening in their new orders index for April. New orders for durable goods Consensus Forecast for April 10: +1.5 percent Range: +0.5 percent to +6.4 percent New home sales in March surged 26.9 percent to a 411,000 annual rate, bumping up the year-ago pace to up 23.8 percent from down 8.5 percent in February. The boost in sales whittled supply down and to 228,000 units from 233,000 in February. Relative to sales, homes on the market eased to a 6.7 months’ supply from 8.6 in February. Clearly, the pending expiration of tax credits helped boost sales—transactions had to close by the last day of April to qualify. Since new home sales are based on contract signings instead of closings, there likely will be a sharp drop in April as homebuyers front loaded contract signings in March to assure enough time to close by April 30. Signings in April would risk not qualifying for tax credits. New home sales Consensus Forecast for April 10: 425 thousand-unit annual rate Range: 390 thousand to 435 thousand-unit annual rate

Thursday
GDP growth slowed in the first quarter to an annualized 3.2 percent, following a fourth quarter surge of 5.6 percent. But real final sales to domestic purchasers rose an improved 2.2 percent in the first quarter after an anemic 1.4 percent rise the period before. Inflation was still soft as the GDP price index rose an annualized 0.9 percent, following a 0.5 percent increase in the fourth quarter. Analysts will be focusing on revisions to final sales as that is now needed to keep the recovery going. Real GDP Consensus Forecast for second estimate Q1 10: +3.5 percent annual rate Range: +3.2 to +3.8 percent annual rate GDP price index Consensus Forecast for second estimate Q1 10: +0.9 percent annual rate Range: +0.9 to +0.9 percent annual rate Initial jobless claims jumped 25,000 in the May 15 week to 471,000. The disappointment included a 2,000 upward revision to the prior week. There were no special factors to explain the latest week's jump. The 471,000 level is the highest in five weeks. But the four-week average of 453,500 does show improvement from mid-April's 461,000. Jobless Claims Consensus Forecast for 5/22/10: 450,000 Range: 445,000 to 462,000

Friday
Personal income strengthened in March, gaining 0.3 percent, following a 0.1 percent rise the prior month. The heavily-weighted wages & salaries component increased 0.2 percent in March after edging up 0.1 percent in February. However, the highlight of the report was that personal spending outpaced income with PCEs posting a 0.6 percent boost in March, following a 0.5 percent jump the month before. The headline PCE price index firmed to up 0.1 percent after no change in February. The core rate also edged up 0.1 percent in March after no change the month before. Looking ahead, personal income in April should be boosted at least by the wages & salaries component as aggregate weekly earnings jumped 0.9 percent for the month, according to the jobs report. PCEs should be moderately healthy as retail sales excluding autos rose 0.4 percent. But the auto component is a question as

unit new motor vehicle sales declined but the auto component in retail sales gained—likely a price effect. PCE inflation should be subdued as the April CPI fell 0.1 percent and the core CPI was flat. Personal income Consensus Forecast for April 10: +0.5 percent Range: +0.3 to +0.6 percent Personal consumption expenditures Consensus Forecast for April 10: +0.2 percent Range: -0.1 to +0.5 percent Core PCE price index Consensus Forecast for April 10: +0.1 percent Range: 0.0 to +0.1 percent The Chicago PMI rose 5 points in April to 63.8—moving further above the breakeven level of 50. Strength was centered in new orders which rose more than 3 points to a very strong 65.2, suggesting another robust number for May. Production was also strong at 63.1 for a more than 2-1/2 point gain. Chicago PMI Consensus Forecast for May 10: 62.0 Range: 55.0 to 64.0 The Reuter's/University of Michigan's Consumer sentiment index for mid-May rose 1.1 points to 73.3, showing strength relative to April but remained down compared to March and February when the index in both months came in at 73.6. A recent firming in initial jobless claims and a plunge in stock prices could bump down consumer sentiment for May’s final reading. Consumer sentiment Consensus Forecast for final May 10: 73.3 Range: 71.0 to 74.0 SIFMA Recommended Early Close 2:00 ET R. Mark Rogers is the author of The Complete Idiot’s Guide to Economic Indicators, Penguin Books, October 2009. Econoday Senior Writer Mark Pender contributed to this article.

Important Legal Notice: Econoday has attempted to verify the information contained in this calendar. However, any aspect of such info may change without notice. Econoday does not provide investment advice, and does not represent that any of the information or related analysis is accurate or complete at any time. Legal Notices © 1998-2010 Actual Data Source: Haver Analytics | Consensus Data Sources: Market News International & Thomson Financial

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