Economic Notes – 9-24-12


Written by: Jon McGraw

It was the week of the month dominated by housing numbers.

The NAHB homebuilder sentiment index rose from 37 in August to 40 in September, which beat consensus estimates of a 38 figure, and was led by all three index components: current sales, expected future sales and prospective buyer traffic. The other good news is that that the index is now at its highest level since mid-2006.

Housing starts rose less than expected in August, at +2.3% month-over-month versus a forecast +2.8%. This translated to an annualized level of 750k units, which is better than the 500k and under figures we became used to during the depths of the financial crisis, but remains below the long-term average level of a million homes a year we need to keep up with population growth. So, better, but still room to go. The good news in this report is that the increase consisted of a +5.5% rise in single-family starts, which offset a nearly -5% drop in starts from multi-family (a surge in multi-family building has been the recent trend). Housing permits fell -1.0% in August, month-over-month, which was better than the expected drop of -1.9%.

Existing home sales rose strongly in August, up +7.8% to an annualized level of 4.82 million units, versus a forecast +2.0% gain. The gain in sales occurred in both single-family homes and condos, although the single-family homes figure was a bit better. This represented more good news for housing, as were existing home prices, which came in at a +9.5% gain on the trailing year. The months’ supply of homes fell to 6.1 months.

We’ve been seeing this trend over the past several months, and housing appears to be bottoming (and even showing signs of growth in some regions). Recent studies done in this area show that a slow start into recovery isn’t unusual and is perhaps more in line with more extreme previous real estate cycles (think the Texas and Oklahoma oil-oriented peak in 1983, California peak in 1986 and New England multi-state peak the same year), where a general price decline lasted for 3-4 years, with subsequent recovery periods taking 5-10 years.

 The national scope of the recent housing bust was unprecedented, but, thus far, the same pattern of decline and recovery in both housing prices and construction activity has held with these regional precedents. Conclusion: we’re still in this recovery and may be for several more years. Also, quick profits in housing may harder to come by compared to the pre-2005-2008 world. Long-term studies by Robert Shiller and others remind us that the long-term annual after-inflation/real rate of return on residential housing is just a shade above zero.

The regional manufacturing surveys have certainly been in the news more than average—much of it due to weakness in recent numbers. The Empire state index from the New York Fed declined further, from -5.85 to -10.41 in September, which was much worse than expected. New orders, shipments and employment were all down and inventories crept up—so universally weaker. Conversely, the Philadelphia Fed Index improved slightly, from -7.1 to -1.9, which was better than expected and again reminded us of the fickleness of these indexes. While shipments were down, new orders here were better and expectations about future business activity were much more positive (in fact, the best reading in 20 years). Also, the Morgan Stanley Business Conditions Index jumped 18 points to 55% for September, which was a bit of a surprise.

On the jobs front, initial claims for the Sept. 15 week were a lower 382k, but still higher than the expected 375k. Some of this carryover may be related to Tropical Storm Isaac, but this effect, if any, seems to be fading away. Continuing claims for the Sept. 8 week, however, fell again and were lower than expected at 3,272k versus the forecast 3,300k. The continuing claims trend is a positive one in recent weeks.

Minneapolis Fed President Kocherlakota made comments this last week regarding the possible longevity of the Fed’s easing plan—alluding to continued low rates until the unemployment rate reaches 5.5% or so (considered to be ‘full’ employment in some economic models). So, assuming current population growth trends and consistent labor force participation, the U.S. will need to generate nearly 145,000-160,000 jobs a month for the next 6 years to hit this goal. Considering the Fed’s dual mandate, one of which is maximizing employment, expect the foot on the gas for some time.

Stocks were a touch lower on the week, with U.S. large cap equities ending with minimal losses, and outperforming smaller-cap stocks and foreign issues. From a sector perspective, telecom and healthcare outperformed, while cyclical materials, financials and energy lagged. Domestic stocks generally beat foreign issues. In the EAFE, the European nations generally underperformed Japan and Australia. Emerging market India led the way with a strongly positive week from a country standpoint, while nations like Brazil, France and Italy were off by the greatest amounts.

From an earnings note, bellwether FedEx disappointed investors. Despite better than expected earnings, they lowered forward-looking expectations, which, considering their unique role in the global economy, is interesting, but didn’t appear to rattle investors too much this week. Managements appear again to be in a race to lower guidance, which should certainly affect investor perceptions of 3rd quarter earnings which will start tricking in during October.

With interest rates lower, long bonds outperformed, led by 20+ year Treasuries, while other investment grade issues were solidly positive. Domestic high yield and foreign debt generally came in negative.

Commodities were generally down on the week, with the exception of precious metals, which gained a bit again on QE easing. The biggest drops were in energy (oil down -5%) and agriculture, the latter due to uncertainty about global economic growth, including a report by the American Petroleum Institute that U.S. oil consumption in August hit its lowest level in 15 years. Interestingly, is still about $6 cheaper per barrel that it was last December, while gasoline is about $0.60 higher a gallon.

We made note of some straightforward comments made by investment icon and Vanguard founder Jack Bogle recently in a publication. Interesting to consider are his long-tested models for forward-looking equity and fixed income returns… stocks should generally return a sum of their current dividend yield plus earnings growth (so, call it 2% + 5% = 7%, on the conservative side). The best estimate for total return for bonds is their current yield (just under 2.5% for the BarCap Aggregate at the moment). Perhaps a simple but effective rule to keep in mind.

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