Economic Notes – February 25, 2013


Written by: Jon McGraw

(0) The CPI inflation number for January was flat, which was a bit less than the slight increase of +0.1% expected.  However, the core inflation number—which excludes more volatile food and energy prices—gained +0.3% as opposed to an expected +0.2%.  The difference was mainly due to an energy price decline in the headline figure, as well as marginal gains in apparel, tuition/child care and tobacco in the core number.  Year-over-year, the headline inflation number was up +1.6% and core +1.9%.  Similarly, the Producer Price Index for January rose +0.2% which was a tick below the expected +0.3% increase (and a year-over-year result of +1.4%).  The core number rose by an identical amount, in line with expectations.

Overall, inflation results remain well-contained, if the CPI and PPI are used as one’s primary measures.  Of course, if one uses one of the many ‘underground’ metrics available, such as one of several historical methodologies or lifestyle-based calculations, you might find a different number—but these are based on different rules and product mixes (one must also account for the technological differences implied in these assumptions).  For example, our food might be cheaper, but many of us might argue cable TV, tuition and health care certainly aren’t.  It’s hard to find a perfect measure here.  But the differences do become important for retirees and future retirees if/when cost of living adjustments for Social Security benefits are tweaked and CPI starts to mean something.  Then, those getting the benefits will begin to care about the calculation a lot.  In that situation, retirees will naturally benefit from the highest (‘most realistic’) inflation number possible, while it will behoove the government (for program sustainability reasons) to keep these increases as low as possible, which may or may not track the actual inflation many of us experience on a day-to-day basis.

(+) The Conference Board’s Index of Leading Economic Indicators rose 0.2% in January to 94.1.  This wasn’t as dramatic as December’s +0.5% jump, but it remains a gain, nonetheless.  As the economists behind the index put it, the underlying results showed a continued trend of slow, but continued expansion—in the recent months, this was led by housing and financial results such as interest rate spread and stock prices.  All-in-all, six of the ten indicators advanced, while consumer expectations for the future and new manufacturing orders were a negative influence.  The ‘coincident’ indicators, which looks at variables that measure current conditions, were up +0.4%, while the ‘lagging’ index of backward-looking metrics rose the same amount.  All point to positive movement, in line with an upward trend of the past six months.

(-) The Philadelphia Fed index underperformed for February, which added fuel to the fire for Thursday’s market drop.  The resulting -12.5 point drop stood in stark contrast to an expected improvement of +1; however, the underlying components were not quite as bad as the index looked, with assessments of the general business climate coming in as worse than the orders, capital spending, shipments and employment metrics themselves.  Additionally, there were some optimistic anecdotes for early 2013…

(+) Existing home sales rose +0.4% in January, which was better than the forecasted decline of -0.8%.  Single-family sales were just slightly up, but condos (nearly +2% higher) were much more significant.  The Northwest, Midwest and South gained, while the West fell almost -6%.  When looked at from a multi-month moving average standpoint, this was the strongest existing home sales reading in three years.

(-) Housing starts fell in January by -8.5%, which was a disappointment compared to the expected drop of -3.6%.  The bulk of the decline occurred in the multi-family category (-24%), which was too much to offset a +1% gain in single-family homes.  On the positive side, December’s starts were revised upward by a few percentage points.  For the year-over-year results, starts are up +20%, which represented a significant improvement and positive trend.

(+) Housing permits were up +1.8% on the month, which was a bit better than the forecast +1.2%.  In this case, single- and multi-family were both up roughly evenly.

(-) The NAHB homebuilder index fell by a point to 46, which fell short of an expected 48 reading.  In the underlying data, single family housing sales fell by a point, and prospective buyer traffic fell by 4.  In general, this data can be a bit of a precursor to upcoming housing starts, but tends to be choppy month-to-month.

(-) Initial jobless claims rose to 362k, higher than the expected 355k for the Feb. 16 ending week.  It appears seasonal adjustment factors may be contributing to the volatility of the weekly series so far this year, which is not unusual.  Continuing claims for the Feb. 9 week came in at 3,148k, which was a touch lower than the 3,150k expected.  However, the prior week’s claims were revised upward by 23k.

(+/-)  We don’t normally put a lot of effort into a recap of the Fed Open Market Committee minutes, since these notes are often received with little fanfare, but the release on Wednesday led to a relatively sharp equity market selloff.  The catalyst was mention of a significant discussion about the risks of QE (in relation to the benefits), and potential timing and factors that would prompt an exit from the program.  As expected, several members appeared to be more inflation-sensitive, while others remained fearful of removing accommodation too soon.

The issue is clarity (of lack of it).  Markets want a clear picture and uncertainty makes participants nervous; bad news outright is almost better than uncertainty in some cases.  Why the worry?  Institutional investors realize how important the Fed stimulus has been in promoting the improvement in risk asset pricing.  Should it be removed too soon, there are fears that the gears of the economic engine are not quite moving fast enough to pick up the slack and keep the car moving on its own (pardon the auto analogies, but these do seem to work well).  At the same time, as noted by several members, excess monetary stimulus can be potentially inflationary if left on in too large of an amount and for too long.  (This explains our assessment of ‘+/-’ on whether this was/is good news or not.  For quite a few reasons, the stimulus has been a mixed blessing in that regard.)

With the risk of this extra ‘gas’ being removed, risk assets retreated.  And, with the risk-off day, it was interesting that a safe haven like gold also lost ground.  Why?  Well, discussion of a premature stimulus exit gives the gold bugs less pent-up monetary stimulus and inflationary pressure to worry about.  So stocks fall, gold falls… so much for a safe haven hedge.  Additionally, with low inflation levels, there is a bit less of a negative ‘real yield’ environment that gold and silver tend to thrive in.  Thirdly, add in the much easier transmission vehicle of the ETF, and gold exposure can be obtained much more easily and cheaply than ever before—so these assets have represented an increasing percentage of overall bullion ownership.

This coming week, of course, we’re likely to see continued battles to avoid the March 1 sequestration deadline…

Market Notes

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In a four-day market week, stocks were off by a fraction of a percent, largely mid-week after the FOMC minutes and Philadelphia Fed Index announcements (noted above), as well as underlying concerns about the sequestration deadline.  Defensive consumer staples and utilities were the best performing, while cyclical materials and consumer discretionary lagged by the largest amounts.

In foreign markets, Japanese stocks were up big again with additional positive pro-growth rhetoric about quantitative easing, creation of some inflation.  This market has gained strongly since Fall 2012 and contains a good deal of quality, world-class companies with solid foreign demand—albeit still appear to be overshadowed by their government’s tinkering with ways to stimulate growth and, indirectly, currency values.  On the losing end, China, Hong Kong, Brazil and Italy (the latter with uncertainty about upcoming elections) lagged on the week.

Bonds were up a bit with a weaker environment for equity assets, and the bond yield curve flattened, with higher rates slightly on the short end and lower rates on the long-end.  Therefore, long bonds gained nearly a half-percent in price on the week, but most bond categories gained at least a small amount.  Foreign bonds were generally negative on the week with weaker currency and spread impact.

Commodity were generally down on the week, in line with global risk assets.  Natural gas and ‘softs,’ including coffee and cotton, were the strongest performers on the week (although small parts of the total index), while grains, general petroleum, precious metals and industrial metals all lost ground (in order from best to worst).  Gold’s niche problems were discussed above, while petroleum declined due to indications that the Saudis would raise production in the next few months.

We have also been taking note of the VIX, which is often misunderstood for good reason—it’s the ‘implied’ S&P 500 volatility looking out 30 days into the future, as derived from the classic Black-Scholes equity option pricing model.  Vol is low again, which has spooked a few people that take the low relative level for investor complacency.  This may or may not be true.  Rising markets have tended to experience lower volatility numbers due to the pattern of how prices and sentiment operate—bull markets tend to be longer-lasting, somewhat subtle and less volatile, while bear markets have been choppy, inconsistent and relatively quick (by comparison).  This tendency mathematically raises the VIX in falling markets.  However, noting some recent research, low starting VIX readings are also correlated to better market returns.

Could we see a bit of a ‘retreat’ in light of recent market strength in the shorter-term?  Sure!  And it wouldn’t surprise us one bit. We generally see 5% corrections no less than five times a year, on average.  And we likely will (we just can’t tell you when or what the opportunity cost might be in the meantime by attempting to time things).  Do fundamentals also appear attractive versus history and other asset classes?  Yes.

Have a good week!