Economic Commentary - Dave's Top Ten List
Merrill Lynch
29 July 2005
This research product summarizes the 10 major macro themes of the past week as a
prelude to our weekly publication the Market Economist.
1. Fed’s Beige Book Quite Rosey – nothing in here that was bearish for bonds and nothing
in here suggesting that the Fed is about to stop: interesting though that “hiring in several
Districts was mixed” and that “overall price pressures eased slightly or remained
unchanged in most Districts, despite substantial increases in energy costs”. Add to that
“nearly all Districts said wage pressures remained moderate”. Not exactly hyped-up talk
regarding an inflation outbreak. Housing was “robust” for the most part but “showed a
few signs of cooling in some Districts” (New Jersey, NY condo market, Richmond,
Atlanta, San Fran, Washington, “several” Florida markets, and ‘parts of” Southern
California). Did we leave anyone out? It would see as though the Midwest housing
market was still firm (“brisk” in Chicago; “solid” in KC and Minneapolis and was cited
as “strong” in Dallas although that is in the south – note that these areas are not in
bubble-land). In terms of sectors, what stood out as being bullish was tourism/travel,
commercial real estate, and advertising. Banking sector conditions cited as “solid”.
Note that the Beige Book did cite that credit quality was becoming a concern in “parts of
Florida” with “several contacts” in the banking sector noting “excessive condominium
construction”. We would have to say that if there is one area that is firing on all
cylinders it is in Texas – the Dallas Fed said that economic activity “strengthened” since
late May, paced by construction and energy projects. There are “more reports of hiring”
and firms, notably those in transportations services are able to pass “costs onto
customers”. Highway and commercial construction are very firm and high-tech
companies say “‘sales are orders” are currently growing at a “healthy rate”. Retailers in
the Lone Star State were one of few to say that sales growth has been “stronger than
expected”. With all of this going on in Texas we wonder what part of the ball game
Dallas FRB President Fisher thinks we are in now – have we at least gone past the Star
Spangled Banner?
2. Possible winners from an appreciating Chinese currency – a look at the export
picture: the losers in terms of greatest import share is simple – toys, electronics,
appliances, furniture, clothing/textiles. In terms of what part of the US export pie to
China has the greatest exposure – tech (15.5% – 11.4% in semiconductors and 4.1% in
computers); chemicals/plastics (11.7% share of what we send to China);
tech/semiconductors (11.4%), industrial machinery (7.9%), aircraft (6.3%), paper
products (4.6%), electrical machinery (3.2%), health care products (2.9%) and
autos/parts (2.3%).
3. Confidence levels receding: a good friend pointed out to us a survey of
small business and consumers that Sam’s club publishes every month – the
latest results are not exactly glowing: The share of small businesses who are
“confident” over the economic outlook was 45.9% in July – this is down 5.4
ppts from a year ago. The share who have little or no confidence rang in at
54% – it was 48% a year ago. On the employment front, 30.5% are saying
they expect more layoffs versus 24.6% a year ago. The share saying “fewer”
layoffs was cut in half to 12% from 25.8% in July/04. On the consumer side,
the Sam’s Club survey showed that similarly, 43.7% are confident over the
economic outlook compared with 47.6% a year ago. And when asked at what
price gasoline begins to hit hard, the majority said at $2.25/gallon.
4. The July Conference Board ‘consumer expectations’ index is generally a
reliable leading barometer for the coming back-to-school shopping
season – note that it fell 3.4 pts to a three-month low of 93. The last 3 times
we saw a dip in July it foreshadowed a mere 1% SAAR pace on ex-auto retail
sales in the three months to September. By way of comparison, the last three
times this index rose in July, it tended to foreshadow a 5%+ SAAR pace in
ex-auto retail sales over the next three months. Be that as it may, the hot
weather did indeed drive people to the malls in July, because the ‘shopper
traffic’ segment of the Richmond Fed’s retail index swung to +5 this month
from -5 in June. This is in contrast, however, to the MNI retail sales index,
which is a survey of 196 companies covering 168,400 stores – it fell to 49.4 in
the four weeks ending July 23rd versus a 52.9 reading on July 16th.
5. Housing still providing considerable stimulus to the economy: new home
sales followed in the footsteps of the earlier-released resale data and knocked
the ball out of the park – up 4% m/m in June to a record 1.374 mln annualized
units, with gains broad based across regions. Median prices edged down to
$214,800 from $227,400 but this likely reflected the regional mix of activity
since the South – generally lower priced areas – posted a huge +5.1% sales
rebound (while the high-priced West lagged with a +2.8% sales performance).
Indeed, the share of lower-priced homes ($150k-$200k) rose to 25% of the total
sales pie from 21% in May. Be that as it may, the median home price is now -
0.4% y/y (for those who claim that home prices nationwide never go down
year-over-year – well, one metric just managed to accomplish that feat) and the
average new home price is now +1.6% versus the 8.0% y/y trend it started the
year at – maybe the price action is starting to fizzle after all. What we do know
is that while the months’ supply of inventory looks firm at 4.0, the number of
homes being put on the market that have yet to be sold jumped 2.5% and now
are up 18.7% y/y which modestly outpaces the y/y sales trend of 16.2%. The
number of homes that are now up for sale but not yet started – perhaps a
reflection of a looming supply overhang – has jumped 57% from a year ago.
The last time this pace was so hot was thirty years ago. Even after 9 tightenings
by the Fed, the banks are still not easing their mortgage lending requirements.
6. The June durable goods report (orders +1.4%; ‘core’ +3.8%) was better
than we and the consensus were looking for, but the reality is that upon
closer inspection there was not a whole lot to write home about: Ex-tech
(tech orders rose 8.6% paced by a massive 18% surge in telecom equipment)
orders actually fell 0.1% last month. We noticed a seasonal quirk that the
Commerce Department has not adjusted for yet – the final month of every
quarter in each of the past 4; 5 of the past 6; and in 7 of the past 10, have seen
tech orders surge and emerge as the high-water mark for the quarter in
question. And in 8 of the past 9, the following month saw tech orders weaken
– posting a negative sign in each of the past five. Core shipments fell 0.4%
and softness was broad-based. Shipments of machinery fell 0.8% in June and
are down in 3 of the past 5 months. Shipments of electrical equipment were
flat. Shipments of primary metals dipped 0.4% and are down now for 5
straight months. Overall, core shipments for Q2 came in at a 4.9% annual
rate which was sharply lower than the 14% pace in Q1 and the weakest
quarter since 2003Q1. Not only that, but there is almost no growth at all
being built into Q3 and this metric is a great proxy for capex. Yes, the
monthly core orders were decent but this is a very choppy series and for Q2 as
a whole, growth came in at only a 3% annual rate versus +20% in Q1. This
was the softest quarter since 2002Q4. Did anyone have a -0.3% June forecast
on manufacturing inventories? For the quarter they were down 1% at an
annual rate – watch this act as a drag on Friday’s Q2 GDP figure. In an
additional sign that industrial activity has started Q3 off on a soft footing, we
see that the KC Fed’s factory diffusion index sank to +1 in July from +11 in
June, led down by shipments, orders and backlogs.
7. More good news for our inflation call: Amazon.com lifted its sales 26%,
but did so by boosting volumes through accelerated discounting – as one
example, to 34% from 30% on books with a publisher’s list price above $25.
Sony just posted a second consecutive quarterly loss and cut its outlook –
why? Because of declining prices of its flat screen TVs. Nomura said Q1
profit fell 80% due to a slump in brokerage fees. Siemens reported its largest
quarterly earnings decline in two years due to losses at its mobile phone unit.
Additional constructive news on this score was seen in the Richmond Fed
service sector survey for July – service sector companies are looking to slow
the growth in their pricing over the next six months – to an average inflation
rate of 1.53%, down from an average of 2.02% in June. Moreover, the WSJ
this past week ran with an article, which found that GM is going to replace
rebates with more permanent reductions in sticker prices through 2006 which
will feed right through into that 10% of the core CPI called ‘automotive’.
Article says that one dealer familiar with the company’s strategy said that GM
intends to CUT prices on 46 of its 2006 models.
8. Layoff announcements gather apace – Kimberly-Clark with an announced
cut of up to 6,000 jobs or 10% of its workforce, and this follows Ford’s
announcement that it is going to deepen its cuts, PFC Financial’s latest
restructuring, as well as Kodak’s and H-P’s big slice. In total, we saw 30,500
job loss announcements last week alone, and despite that we have a Fed that is
concerned over the (remote) possibility of a slowdown in productivity growth.
How this list of layoff notices combined with the already sub-par pace of job
creation (which for some reason policymakers and Street economists believe is
firm) dovetails with a sustained productivity downtrend is anyone’s guess.
Moreover, what ever happened to that so-called American Jobs Creation Act
that allowed U.S. companies to bring home untaxed profits at a 5.25% rate
(instead of the 35% rate they would ultimately face)? Did you know that 6 of
the 10 companies repatriating the largest sums are actually CUTTING jobs in
the United States? Have a look at the article on page 34 of BusinessWeek
(“Profits Head Homeward, But Where are the Jobs?”). Note that the
Challenger layoff announcements have been rising dramatically in recent
months – over 100,000 last month. A ‘typical’ June sees 52k in layoff
announcements. In fact, from September to April, the layoff announcements
have consistently outpaced what is ‘normal’, and by an average of nearly 60%.
9. More Fed tightening being priced in: The Fed futures contract is priced for
a 100% chance of a 25 bp hike on August 9th and an 8% chance of a 50
beeper. At 3.745%, the market is also nearly fully priced for another 25
beeper on September 20th. The futures contract can’t decide on November
1st and is only priced 70% of the way for another move then, but to make up
for it, it is 100% priced for a 4% funds rate as of the December 13th meeting
and 12% odds that we finish the year at 4.25%. Say we do – that means the
2-year note yield in the vicinity of 4.5% and the prospect of an inverted yield
curve. And while the Fed is fading the curve, the five times that the Fed
tightened into an inversion over the past 4 decades all led to recession within
the ensuing 12 months.
10. Homeowner affordability sank to 14-year of 117.1 in June from 123.3 in
May and down 5% from the 123.7 level a year ago. The last time
affordability was this stretched was back in September 1991 when the 30-year
fixed rate mortgage was 8.85% – as opposed to 5.72% today. This goes to
show just how far home prices have outstripped incomes and how much debt
households have strapped on this cycle that such a low level of borrowing
costs could elicit such a huge falloff in affordability ratios. For first-time
buyers, median family income has risen 3% in the past year while the average
price of a starter home has gone up 10%. As an aside, this affordability
squeeze has begun to show through in reduced homeownership rates – down
in Q2 to 68.6% from 69.1% in Q1 and 69.2% in Q4. The biggest decline was
in the high-priced West – down to 63.8% from 64.9% in Q1. |
