While last week's data were mixed, I remain bullish on the US recovery. I believe it is more important to focus on big-picture, long-term trends and be a bit cautious in interpreting some of the short-term data. I (along with the rest of the economist community) think that this week's US GDP report will show a fourth-quarter growth rate of over 5% compared to 2.2% in the third quarter and a decline of 0.7% in the second quarter. Remember that real GDP is the broadest measure of economic activity. Although a large improvement is widely anticipated, I believe a headline number that big (along with the inevitable commentary, "Best growth rate since 2003!") splashed on the front of every newspaper across the country could provide a psychological lift.
China tightens again
Although last week's economic data weren't the best, I don't think that
was why equity markets had such a bad week. The Dow was down 3.7%
following a fractional decline the week before, while the FTSE 100 lost
2.8%. More important was news out of China that pointed to continued
tightening as the government tries to get its arms around some pretty
aggressive lending policies. This in turn could lead to slower growth in
China, which has been a key engine in the worldwide economic recovery.
As a big user of many commodities, slowing growth in China could lead to
lower commodity
prices as well. While the market was getting jittery, Dan Su, our
analyst covering Chinese data, believes that it was a positive sign that
China was trying to put the stopper back in the bottle before the
expansion and inflation level in China got out of control.
Financial reform resurfaces as an issue
On top of the China news, Thursday the Obama administration proposed
limits on both the size and trading activities of banks. Besides
affecting bank stocks directly (financials are still an important part
of the general market indices), there was also fear that the regulations
might make it tougher to trade financial instruments and raise the cost
of capital. Higher costs of capital weigh directly on the valuation of
securities.
The impact was abrupt in one case. Our energy team reported that a $1.7 billion bond deal from a major gas pipeline company had to be pulled on Thursday because of the uncertainty created by the new proposals. The Democrats' loss of the Massachusetts Senate seat--and potentially the health-care bill--certainly helped shift attention to potential financial reforms. Also, the potential for even more proposals from the Obama administration thoroughly spooked the markets, regardless of what was going on with either companies or the economy.
Shot-term economic data a mess of special situations
Last week the statistics were so badly muddled that it was really hard
to draw too many conclusions. In this particular week, holidays,
weather, and seasonal adjustment factors made the numbers difficult to
interpret. And I have more bad news: it's going to get even worse from
here. In February, the US job statistics will get restated and
reformatted. Some of the revisions are likely to be substantial, and my
guess is that the jobs situation will look meaningfully worse for early
2010 than previously reported, primarily due to construction jobs.
Soon the hiring for the US Census Department's decennial count will begin. Between January and April of 2010 the Census Department is likely to add over 700,000 jobs and then ramp down through the rest of the year. Many sceptics note that these jobs are low-paying, temporary, and often just part-time. However, I think the jobs will serve to prime the economic pump, with more income flowing to those most likely to spend it.
The on-again/off-again housing credit is set to expire at the end of April, throwing the housing numbers into disarray yet again. Retail numbers for January could be a tough call, too. Decent holiday sales meant fewer post-holiday sales and not much inventory left to sell. Then these numbers will be compared with January 2009, which was unusually strong because of massive, highly discounted post-holiday free-for-alls. So hang on for a wild ride and keep the big picture clearly in mind:
1. The housing market is operating at about one third of natural demand
2. Auto sales are still running well below trend line demand
3. The inventory restocking cycle still has a long way to run
4. Stimulus spending should accelerate
5. Exports to developing markets should continue to increase
6. Productivity has been incredibly strong
Mixed housing data
The week began with housing starts and permits that pointed in opposite
directions. Housing starts came in at 557,000 units, down about 4% from
November. Meanwhile, housing permits moved up 10.9% to 653,000 units on
an annualised basis. One possible explanation for the dichotomy is that
bad weather in December caused fewer builders to put shovels in the
ground. Permits, however, represent paper filings that don't require the
cooperation of the weather (except to drive to the filing office). Keep
in mind that housing starts were well over 2 million units at the peak,
and the housing team views 1.5 million units as a level of natural
demand. While there is still a significant but falling amount of
inventory in the system, I believe a meaningful portion of that
inventory is in undesirable locations or unacceptable conditions.
Initial unemployment claims jump
By far the biggest disappointment of the week was the initial
unemployment claims report, which came in much higher than I had
anticipated. Claims jumped to 482,000 from an upwardly revised 446,000
the week before and are now back at their highest level since July. I
should caution that the weekly numbers are quite volatile, and
apparently some claims that didn't get processed in the holiday weeks
may have been put in the hopper for a later week. The less volatile
four-week figure was up a more benign 7,000. With Martin Luther King Day
last Monday, the numbers will still be messed up for the next two weeks
(too few filings next week and more in the hopper for the following
week).
Manufacturing acting better than I expected
Both the Empire State and the Philly Fed regional manufacturing reports
continue to forecast continued expansion in January. The recent Empire
State number was particularly strong and showed acceleration versus
December. Last week's Philly Fed manufacturing report, while still in
expansion mode (any number greater than zero) at 15.2, was down from the
prior month and modestly below expectations. The good news in that
report was that the labour component reached a new high for this
recovery and was now higher than at any time since mid-2008.
This week GDP growth for 4Q could spurt to 5%; Don't be afraid of
poor housing number
The biggest number on tap for this week is the real GDP growth measure
for the fourth quarter. I expect the number to show growth of 5% or more
on a seasonally adjusted annual rate basis when compared to the third
quarter. This would be a great number and would speak to a significant
improvement in the economy.
My opinion has been that once an improving economy is visible, it would create a virtuous cycle of progress. More spending means more production, which means more jobs and ever more income and spending. The large GDP growth number may be just what it takes to put consumers in a better mood.
That said, there will be a few things to be careful about in the release. Most importantly, the inventory component of GDP is likely to account for at least half the gain. It is truly amazing how inventory was drained out of the system this time around. Restocking should continue to benefit the quarters ahead. On the other hand, consumer spending is likely to be up a more modest 1.0%-2.0%--but still up, despite the Cash for Clunkers benefit experienced in the third quarter but removed prior to the fourth. Recent news on the import/export front is likely to be neutral to a bit of a drag in the fourth quarter. Exports are doing really well, but as consumer spending picks up so will imports, since a lot of hard goods are imported from overseas. Investment spending overall should be relatively neutral with residential housing down just a bit, commercial real estate down, and business ex-construction spending trending up.
The week will start off with existing home sales for December that look to be down big compared to November. November sales were substantially inflated at 6.5 million units as buyers rushed in prior to the potential expiration of the homebuyers' credit (it was subsequently extended). For December, I'd suspect existing home sales to be down 10% or more to about 5.8 million units on an annualised basis because pending home sales for November were down over 16% and up just 4% for October. These pending sales would turn into final existing home sales 30-60 days later. To put my 5.8 million unit forecast in perspective--sales bottomed at 4.5 million units in January and averaged just 5 million units for the first 11 months. Because of the homebuyers' credit situation, only October and November saw sales greater than 6 million units.
The Case Shiller Price Indices will also be out this week, and our housing analyst Eric Landry believes prices will be down about 0.5% in November compared to October after showing some increases this summer and a flat reading for October. On a year-over-year basis prices are likely to be down just 5% or 6%--a lot less than many feared at the beginning of the year. These numbers are likely to be negative until the spring selling season and are not a cause for major concern. Nevertheless, I will keep a close eye on these numbers for any further deterioration.
Durable goods orders are also due this week; I expect an increase of about 1% based on earlier positive results from various purchasing managers' surveys. I was a little fearful in late 2009 that manufacturing, which was strong earlier in the recovery, might take a pause this winter. So far I have been wrong.
