The Week That Was, 29 September 2012

by Stephen Swanson

We enjoyed a week very rich in US economic data releases covering most sectors of the economy including final revisions to estimates for second quarter growth in GDP and readings on industrial production, business investment, residential investment, consumer confidence and consumer incomes and spending. We’ll review the releases and see if we can piece it together.  We will see if there is a quilt to be made from all the patches.

…GDP Disappoints ….

Real GDP growth was unexpectedly revised down for the second quarter. The Commerce Department is now estimating growth at a 1.3 percent annualized pace, compared to the second estimate of 1.7 percent and advance estimate of 1.5 percent. The latest number is sharply slower than the 2.0 percent seen in the first quarter and the 4.1 percent surge posted for the fourth quarter of last year. Clearly the trend is towards slowing growth.

… But Not as Much as Durable Goods…

Similarly, you would have had to look very hard to find any good news in the latest durables report which offers insight into both manufacturing and business investment. New factory orders for durables plunged a whopping 13.2 percent (monthly) in August after a revised 3.3 percent boost in July. Excluding transportation, orders dipped 1.6 percent, following a 1.3 percent decline in July. Manufacturing has lost significant momentum with non-defense aircraft leading the way down.

The transportation component fell 34.9 percent after a 13.1 percent gain in July. Leading the way down, civilian aircraft orders dropped a monthly 101.8 percent. Boeing lost orders net for the month. Motor vehicles also contributed to the drop in transportation orders, falling 10.9 percent after a 12.1 percent advance the prior month. The one bright spot is non-defense capital goods orders excluding aircraft edged up 1.1 percent in August, following a decrease of 5.2.

… And Manufacturing Generally Weaker…

The trend in declining orders for durable goods tends to be reinforced by declines in manufacturing indices released by the Chicago PMI and a number of regional Fed surveys, although the latter offer a more mixed view. Last week we had an improvement in Philly Fed index even though it remains in contraction and a very downbeat report from the Empire State Fed.

As reported by the organization:

“The Chicago Purchasing Managers reported the Chicago Business Barometer fell to 49.7, its lowest level in three years. Among the Business Activity measures, five of seven posted declines as New Orders fell below 50 and Order Backlogs contracted for the fourth of the past five months. Prices Paid showed the biggest gain in nearly two years and Supplier Deliveries moved back above 50.”

… While Fed Regional Surveys were Mixed…

Among the regional Fed surveys showing deteriorating conditions, the Kansas City Fed composite index eased to 2 from 8 in August while the Chicago Fed’s national activity index fell to minus 0.87 in August from a revised minus 0.12 in July, pulled down most by declines in production-related indicators, The three-month average is also sinking more deeply into contraction, from a revised minus 0.26 in July to minus 0.47 in August which is the lowest level since June last year.

Texas factory activity increased in September as the production index rose from 6.4 to 10, suggesting stronger output growth. And modest manufacturing momentum was seen in Richmond Fed survey whose manufacturing index rose to four for the first positive reading since May.

…. And Home Prices Continue to Improve But Pressure Sales….

On the housing front, data released this week suggests rising home prices may be constraining both new home and existing home sales. Home prices continued to trend higher in July but at a slowing rate, based on S&P Case-Shiller data that show an adjusted 0.4 percent monthly gain for the 20 city index. This is the sixth straight monthly increase for the adjusted index though it is the slowest gain since February.

But prices appear to be holding down new home sales which slipped 0.3 percent in August to a 373,000 annual rate. The curve for sales has flattened a bit the last couple of months but the longer term trend is still upward. Regional data are mixed showing monthly gains for three of the four regions but a third monthly decline for the South which is by far the largest region.

Pending home sales fell 2.6 percent in August pointing to trouble for final sales of existing homes. Both a low supply of houses on the market and firming prices are key factor holding down sales. Existing home sales have been trending upward but not by very much and today’s report points to the risk of slowing or of flattening or even worse.

Possibly tempering this slowing rise in home sales, new lows for mortgage rates are boosting mortgage applications both for home purchases and for refinancing. The purchase index rose 1.0 percent in the September 21 week with the refinance index up 3.0 percent. But mortgage bankers are busier with refinancing than they are for purchases with refinancing making up 81.2 percent of total applications which is the highest percentage since early August, diluting the argument rising purchase applications hint at future strength in home sales.

Even With All This, Consumer Confidence Improved …

Against this generally gloomy backdrop, consumer confidence appears to be increasing. The Conference Board’s index of consumer confidence, after being down 4.8 points in August, jumped a very strong nine point in September to 70.3. Similarly, the Bloomberg Consumer Comfort Index rose to minus 39.6 from minus 40.8 the week before placing the index at its highest level in two months on the back of lower initial unemployment claims

The Reuters/University of Michigan survey is a bit more nuanced. The Reuter’s/University of Michigan’s consumer sentiment index in early September was up a very sharp 4.9 points to 79.2, about the best reading of the year. Consumers, however, saw the second half of this month as decidedly less positive than the first half, based on the consumer sentiment index which fell to 78.3 from 79.2 at mid-month. Still, the final September reading compares very well with 74.3 in August as well as July’s 72.3.

… Even Though Consumer Income Was Less So …

August was a mixed month for consumer income, spending and inflation. Income growth came in soft, spending was up on higher gasoline prices and autos, and inflation was high on the headline but modest on the core. Personal income in August rose a modest 0.1 percent after a gain of 0.1 percent the month before but real disposable income fell by .3 percent from the prior month. Nominal spending rose by 0.5 percent but real spending rose by only 0.1 percent from the prior month. As a percentage of income, spending on food and energy is accounted for a larger share while savings fell from 4.1% in July to 3.7% in August.

… With Increased “Survival” Spending

To put all of the foregoing in context, it may be constructive to examine the BEA’s third and final estimate for growth in the second quarter of 2012. Of the 1.3 percentage points of growth reported for the quarter, 1.06 percentage points of growth came from PCE and, of this, almost 1.0 percentage points came from spending on services. And fully 69% of this came from spending on household expenditures such as food, energy and health care. So, 0.7 points of 1.3 points of growth (over half) resulted from expanded spending on household essentials, not the spending that signals robust expansion. Private investment was almost a wash with a slight expansion in fixed investment offset by a contraction in inventories. And a lower dollar allowed our balance of trade to improve and actually contribute 0.23 points of growth.

Over All the Best Characterization Might be “Stall Speed Stagnation”

Of the data released this week, there is little to suggest the composition and direction of the economy will change, notwithstanding QE3. Incomes drive consumption and consumption of durables drives manufacturing and investment. The problem, though, is that real incomes are contracting suggesting consumption of durables, manufacturing and business investment will follow suit. And it appears to be happening.

Two week ago the Fed reported a broad contraction in industrial activity, with declines in manufacturing, mining and power generation. The ISM PMI registered 49.6 percent in August, indicating contraction in the manufacturing sector for the third consecutive month. This month the highly respected Chicago PMI fell into contraction along with what we can call a collapse in orders for durable goods.  Markit Flash PMI continues to show expansion but this is more than offset by the dour tone of regional Fed surveys. Manufacturing and business investment are both constrained.

Consumer confidence is perplexing but is unlikely to sustain spending on durables or housing and is likely to fall after campaign media distortions ebb. Housing actually subtracted from growth in the second quarter and it appears price increases will slow further gains, reducing the likelihood housing will be a source of growth notwithstanding the voices of pundits and others looking for growth catalysts. Meanwhile, auto manufacturing and sales contributed little to second quarter growth and at a rate much lower than preceding quarters. The durable goods report, a leading indicator, shows an 11% decline in orders for motor vehicles and parts suggesting weakness in auto sales.

Through the lens of this analysis, QE3 dollar devaluation could make exports one of the few bright spots however small.

With business confidence mixed and non-financial businesses sitting on close to $2 trillion in cash, QE3 is unlikely to change this landscape given the law of diminishing returns, uncertain monetary transmission channels, decaying global conditions, regulatory uncertainty and the pending fiscal cliff. If anything, it could boost headline inflation and necessitate greater spending on food and energy as incomes stagnate making us increasingly vulnerable to any shock resulting from festering problems in China, Europe and the Mid-East.

It remains the precarious New Normal. The patches do create a quilt, and we had better hang on to it. Warmth might be welcome this winter.

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About the Author

CautiousInvestorStephen Swanson has a degree in economics and an MBA. His corporate experience includes several executive positions including a divisional VP assignment. More recently he has left the corporate world and has been investing in financial instruments and real estate, with interests expanding into S&P futures and commodities. Stephen is known on the internet under the pseudo nom CautiousInvestor and is a frequent commentator at Seeking Alpha where he also posts blogs.