The Week That Was 20 October 2012

Written by Stephen Swanson

Much economic data was published this past week and the scope of the releases was sufficiently broad as to allow inferences to be drawn as to how most sectors of the economy are performing even though the picture remains mottled and messy. Economic cross currents arising from anemic domestic growth, slowing global growth, unprecedented fiscal and monetary policy intervention and growing uncertainty are very much evident in the data.

U.S. Consumers

Beginning with consumer confidence, the Bloomberg Consumer Comfort Index advanced to minus 34.8 in the latest week on its scale of minus 100 to plus 100, up from minus 38.5 last week to its best since April 15 and one of its best of 2012. Economic expectations show mixed signals: Thirty percent of Americans say the economy is getting better, the most since March. But more, 37 percent, say it’s getting worse, versus 34 percent last month but still down from this year’s high of 45 percent in August. (Thirty-three percent think things are staying the same.)

Other measures of consumer confidence continue to advance as well with the last reading of the Conference Board Consumer Confidence Index posting 70.3, well above expectations. Says Lynn Franco, Director of Economic Indicators at the Conference Board:

“Consumers were more positive in their assessment of current conditions, in particular the job market, and considerably more optimistic about the short-term outlook for business conditions, employment and their financial situation. Despite continuing economic uncertainty, consumers are slightly more optimistic than they have been in several months.”

Improved consumer confidence is influencing spending decisions and during the past week the Commerce Department said retail sales climbed 1.1 in September following a revised 1.2 percent increase in August which was the biggest since October 2010 and larger than previously reported. Compared to September 2011, nominal retail sales were up 5.4% over the year. Total sales for July through September 2012 period were up 4.8% from the same period a year ago.

The details of the retail sales report showed broad strength, with sales outside autos, gasoline and building materials — a closely followed barometer of consumer spending — climbing 0.9 percent last month, which was well above expectations. Motor vehicle sales also were strong and gained 1.3% (8.1% y/y), coming after a report earlier this month that unit sales of light vehicles rose 3.0% (13.9% y/y).

The only caveat is that retail spending captures only a fraction of consumer spending but, nonetheless, is consistent with more comprehensive reports released by the BEA showing wide increases in consumer spending while real personal disposable incomes are in decline. Not by coincidence, personal savings declined in the latest reporting month (August) and the Federal Reserve reports revolving credit balances increased at a SAAR of 8% in August.  It’s fair to ask whether the spending is sustainable.

U.S. Housing Market

Improved consumer confidence also appears to be weighing favorably upon the housing market. New housing starts surged in September to a SAAR of 872,000, 15.0% above the revised August estimate of 758,000 and 34.8% above the September 2011 rate of 647,000. Single family starts increased 11.0% while volatile multi-family starts exploded almost 21% to a SARR of 260,000. Permits followed a similar arc with total privately owned housing permits increasing a SAAR 11.6% in September over the prior month, led by multi-family with single family permitting increasing a SAAR of 6.7%

It’s certainly good news housing is improving but the bad news is that housing starts are still only at 40 per cent of their peak in January 2006, a sign that the recovery still has a long way to go. How far can it go? Current residential construction account for approximately 2.4% of GDP while in the 90’s it averaged 4.1% of GDP, suggesting a potential increase of 1.7 points of growth. Assuming housing returns to its normal role within three years, this would suggest housing could add around .6 points of growth to GDP in the coming years barring one or more economic shocks. It’s not the magic bullet as some say because of its historical role, tighter underwriting standards, unemployment challenges and a preference among many to rent.

Almost as if to remind us to not bet the ranch on housing, existing home sales fell back in September after two prior months of strong growth, down 1.7% to an as-expected 4.750 million for what is still the second best annual rate since the stimulus programs back in the spring of 2010. September’s details show weakness but also strength. Sales in three of four regions show single digit declines with the South, which is by far the largest region, showing a fractional gain. Prices dipped fractionally in the month though the year-on-year rate for growth of the median price ( plus 11.3%) is in double-digit ground for the first time of the recovery.

U.S. Leading Economic Indicator

Against this generally upbeat and solid backdrop of retail and housing, the Conference Board on Thursday reported that its leading economic indicator (LEI) index rose 0.6% in September after declining a downwardly revised 0.4% in August. A prior estimate for August pegged the decline at 0.1%.  According to Ken Goldstein, an economist at the Conference Board, a New York research group:

“The single biggest challenge remains weak demand, domestically and globally.”

The U.S. economy appears to be fluctuating around a slow growth trend with intermittent spurts of growth, evident in both the consumer and industrial sector.

U.S. Manufacturing

This dynamic is evident in industrial production which rose 0.4 percent in September after having fallen 1.4 percent in August. For the third quarter as a whole, industrial production declined at an annual rate of 0.4 percent.

The Fed report showed manufacturing output increased 0.2 percent in September but moved down at an annual rate of 0.9 percent in the third quarter. The production of consumer goods was unchanged in September after having fallen 1.5 percent in August. For the third quarter as a whole, output moved down at an annual rate of 0.8 percent, as a decline in durable goods more than offset an increase in non-durables.

For September, the output of durable goods dropped 1.7 percent. Among durable consumer goods categories, the production of automotive products fell 2.9 percent, a second consecutive large decline. The indexes for home electronics and for miscellaneous goods posted smaller declines, and the index for appliances, furniture and carpeting moved up. The production of non-durables advanced 0.6 percent, with increases in the output of both energy products and non-energy goods.

Production of motor vehicles and parts decreased 2.9 percent after a 5.1 percent drop a month earlier. The decrease is at odds with improving auto sales and may indicate automakers are trying to trim inventories. Cars and light trucks sold at a 14.9 million annual pace in September, the most since March 2008, according to Ward’s Automotive Group

The degree of contraction eased in the New York Manufacturing region, which is about the best news that can be found in October’s Empire State report. The general business conditions headline improved from minus 10.41 to minus 6.16 which indicates monthly contraction but at a less severe rate than September. The rate of contraction also eased for new orders which are at minus 8.97 vs. September’s minus 14.03. But contraction deepened for unfilled orders, to a very severe minus 18.28 vs minus 14.89.

The Philly Fed General Business Conditions index posted 5.7 in October, up from -1.9 in September. But October’s headline is not entirely supported by strength in the details as new orders are back in contraction, though only slightly and unfilled orders continue to contract though at a less severe rate. Shipments, which have been in contraction since May, are nearly steady. Less positive is employment where contraction is deepening. And delivery times are shortening dramatically which points to slack in the supply chain and slow business for shippers.

U.S. Employment

The choppy, slow growth trend can also be seen in first time unemployment claims. The Department of Labor reported weekly jobless claims swung up to 388K from a revised 342K orignally reported as 339K. It was expected California, as it usually does, would report a jump in claims at the beginning of the quarter due to seasonal adjustments. Instead, the jump happened the second week, but the surprise was that it didn’t come from California where claims were down even further from a week earlier.  The increase came from gains across many other states.  This violent swing in weekly jobless claims raises the importance of the four-week average which inched up less than 1,000 to 365,500. Significantly, this level is more than 10,000 lower than the month ago trend.

European Summit

On the international front, there were a number of important developments with the two most important being the European Summit held Thursday and Friday and the release of Chinese economic data. The Summit brought together European leaders to build upon the momentum of a June plan to spur investor confidence by investing the European Central Bank with regulatory authority for banks across the euro area. There was also discussion of Greece, Spain and a euro-wide financial transaction tax.

Before the summit began, Germany and France clashed over giving the European Union greater control of national budgets and moves towards a single banking supervisor. Angela Merkel demanded stronger authority for the executive European Commission to veto national budgets that breach EU rules, but French President Hollande said the issue was not on the summit agenda and the priority was to get moving on a European banking union.

Eventually, the leaders did agree on rudimentary steps towards creating a eurozone bank supervisor under the control of the ECB by committing to:

The European Council invites the legislators to proceed with work on the legislative proposals on the Single Supervisory Mechanism (SSM) as a matter of priority, with the objective of agreeing on the legislative framework by 1 January 2013.

But far less clarity was achieved on the next step of the process, which many officials consider far more important: when will the Eurozone’s €500 billion rescue fund, the European Stability Mechanism, be able to pump cash directly into failing banks. It was simply agreed that work on the operational implementation will take place in the course of 2013.

Presently, countries like Spain and Ireland must borrow cash to do this on their own and it was suggested in June when the euro banking supervisor was first proposed that once the supervisory mechanism was in place the ESM would directly inject cash into banks and could potentially wipe out billions off Irish and Spanish sovereign debt.

This is growing increasingly remote due to Germany’s vagueness on timing and later statements that the ESM will be restricted from taking on “legacy” assets such as those already mentioned. Shortly after the Summit the FT reported Angela Merkel as saying:

“…bad assets held by Spanish and Irish banks may not be cleaned up by the eurozone’s €500 billion rescue fund, arguing that it should only be used to shore up teetering financial institutions. It will not be a retroactive direct recapitalisation [from the rescue fund].  If direct recapitalization is possible, it will come for the future.”

Were this not enough to create doubt and uncertainty, the FT reported that a “plan to create a single eurozone banking supervisor is illegal, according to a secret legal opinion for EU finance ministers that deals a further blow to a reform deemed vital to solving the bloc’s debt crisis.

A paper from the EU Council’s top legal adviser, obtained by the Financial Times, argues the plan goes “beyond the powers” permitted under law to change governance rules at the European Central Bank.

The legal service concludes that without altering EU treaties it would be impossible to give a bank supervision board within the ECB any formal decision-making powers as suggested in the blueprint drawn up by the European Commission.

So while the European Commission and political leaders accomplished far less than hoped and face serious obstacles, they did, on the taxpayer’s euro, manage to savor delicacies unique to summits including one meal comprising a tarte stuffed with fine eggs and mushroooms, briased veal on a bed of fresh spinach followed by a chocolate trio. Bon Appetit.


Moving from the always exciting and unpredictable Europe to the Middle Kingdom, the National Bureau of Statistics reported GDP expanded 7.4 percent in the third quarter from a year earlier. Investment, retail sales and industrial production all accelerated at the end of the quarter, leading Premier Wen Jiabao to declare that the worst was probably over. The latest Chinese figure is well below both last year’s 9.3 per cent expansion and the nearly 10 per cent average growth rate notched up over the past three decades. The slowdown has disproportionately affected sectors related to infrastructure and investment, such as steel, construction and carmaking and that has had a knock-on effect for countries like Australia and Brazil that export the commodities needed to fuel these industries.

Following the release of the GDP data a storm of comment and analysis followed, primarily dealing whether China is in the process of bottoming out and the reliability of the data. Bloomberg reported that China’s economic growth has started to stabilize, based upon remarks made by Premier Wen Jiabao published the official Xinhua News agency. The government is confident of achieving annual targets and the economy will continue to show “positive changes,” Wen said, according to Xinhua. The State Council said today that it will maintain proactive fiscal and prudent monetary policies this year.

China’s economy is performing better than expected, and the bottoming will be clear in the fourth quarter,” said Zhu Haibin, Hong Kong-based chief China economist for JPMorgan Chase& Co. The possibility of another interest-rate cut this year is getting “quite small,” though the central bank may cut lenders’ reserve requirements, Zhu said.

At the other extreme, Li Wei an economist a Standard Chartered in Shanghai believes the growth is too good to be true.

Mark Williams and Qinwei Wang, economists with Capital Economics in London, wrote in a note yesterday:

“The speed of the turnaround implied by the official figures is implausible. Analysis  of data including freight, electricity output and construction suggests that conditions on the ground are weaker.”

Williams was previously Asia economist for the U.K. Treasury and Wang formerly worked at the People’s Bank of China.

Standard Chartered also questioned the acceleration of industrial production in September to a 9.2 percent pace from a year earlier from 8.9 percent in August, a three-year low. A production sub-index of September’s official purchasing managers index “was flat compared to the average reading of the previous two months,” Li said.

Capital Economics said its own analysis indicates the economy expanded about 6.5 percent in the third quarter, below the 7.4 percent year-over-year growth reported by the government yesterday

While it takes time to organize and edit reporting of data releases, the challenge is to mentally pour through the data, place it in context and correlate it with larger macro economic variables. While this week’s news was generally welcome, it does nothing to change the fact we are in a synchronized global economic slowdown with contraction in manufacturing. Whether China’s growth rate is 7.4% or 6.5% has little bearing on the larger forces at work. Debt remains excessive, fiscal imbalances persist and Europe is not taking needed steps as quickly as required.


With weak global growth, falling aggregate demand and ebbing trade we must look within for growth catalysts. Notwithstanding volatility in employment and the reduction in the U.S. unemployment rate to 7.8% and the announcement of QE3, there is little to suggest that there will be structural improvements in employment over the near or medium term. Combined with stagnating/declining real incomes and improved consumer confidence hovering near recessionary levels, this will contain economic growth. Sharp increases in consumer spending are not likely to prove sustainable and investments in housing are unlikely to deliver the growth many expect. The largest promises for the U.S. remain “insourcing” and massive increases in energy production. The largest threat is the “fiscal cliff.”

Assuming the EMU works through its problems without precipitating a crisis, China does not endure a hard landing (crash) and we do what is required to avoid falling over the fiscal cliff, it’s not unreasonable to expect economic growth of 1.5% to 2.0% until the potential and promise of insourcing and vastly increased energy production is realized. But it cannot be over emphasized how precarious our circumstances are and how vulnerable we are to any type of shock, whether it be economic, financial or geo-political.

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CautiousInvestorAbout the Author

Stephen 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.