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There has been talk of recession for some time now – with the sharp declines in equities being a recent key focus along with housing. Even though the financial sector is still providing plenty of entertainment, it is past time to pay more attention to the real sector. Whether or not it will become an official recession is still a question, but what is not is that the real sector now is in widespread contraction. This past week’s economic news clearly shows that the real sector downturn has spread well beyond housing. The good news, however, is that inflation pressures are softening, making the Fed’s job easier.
 Equities ignored much of this past week’s news on economic indicators and focused on announcements related to government actions to improve liquidity in the credit markets. The week got off to a good start on Monday with the Treasury’s announcement of a plan to recapitalize banks by having the Treasury buy equity in banks. The Treasury stated that $250 billion of its $700 financial rescue plan would go to buying equity in banks, providing them with liquid Treasury assets. Also, before the open, the Fed and a number of other central banks announced a coordinated action to boost liquidity in foreign credit markets. Coming off the worst week in decades, stocks surged on Monday with many indexes posting double digit gains for the day.
But equities reversed course at midweek on underperforming earnings news – notably on Tuesday for PepsiCo, Microsoft, and Intel. Profit taking also weighed on stocks. But on Wednesday, equities did pay attention to the dreary economic news – a sharp drop in retail sales, a very negative Empire State manufacturing index, and a gloomy Beige Book released by the Fed. Retail sales fell a whopping 1.2 percent in September. Also rattling the markets were statements in the Beige Book that the Fed's regional contacts have become "more pessimistic" and that "consumer spending decreased in most Districts." At mid-week, the Dow had its second largest point loss ever – 733 points.
Despite a huge drop reported for industrial production on Thursday – along with very contractionary numbers in the Philly Fed manufacturing report – equities rebounded notably on Thursday. Boosting stocks was a sharp decline in oil prices (to below $70 per barrel) and a tame CPI report. The flat headline CPI was seen as raising the odds for another Fed rate cut on October 29. Equities slipped on Friday on profit taking and concern over a string of blue chip earnings reports this coming week.
Despite volatility during the week, all major equity indexes posted their first weekly gain since September 12. The bottom line is that traders and investors have been focusing on any signs of pending improvement in credit markets. Unfortunately, they may have downplayed too much of the negative economic data.
Equities were up this past week with blue chips leading the way. The Dow was up 4.7 percent; the S&P 500, up 4.6 percent; the Nasdaq, up 3.7 percent; and the Russell 2000, up 0.8 percent.
For the year-to-date, major indexes are down as follows: the Dow, down 33.3 percent; the S&P 500, down 35.9 percent; the Nasdaq, down 35.5 percent; and the Russell 2000, down 31.3 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury yields generally firmed this past week as the government’s initiatives to bolster the credit markets have given investors greater confidence that the credit markets will improve. In turn, traders have seen less need to to cling to the safety of Treasuries – especially the 3-month T-bill which has been trading at rates close to zero. Yields rose significantly on Tuesday after the Monday announcement by the Treasury of its intention to buy bank equities. The bond market had been closed on Monday in observance of Columbus Day. Some flight to safety did occur on Wednesday on the spate of negative economic news that day.
 But net for the week, investors were more confident about the credit markets and were willing to move funds out of near-end Treasuries which had been an extreme safe haven. Despite the rise in rates on the near end, short-term Treasuries are still a refuge for many as the 3-month T-bill remained below a 1 percent yield.
For this past week Treasury rates were mostly up as follows: 3-month T-bill, up 61 basis points; the 5-year note, up 5 basis points; the 10-year bond, up 5 basis points; and the 30-year bond, up 17 basis points. The 2-year note was down 2 basis points.
Despite this past week’s good news on the inflation front, longer rates remain relatively high compare to near end rates.
 While the equity markets may not have paid much attention to the economic news, the oil markets certainly did. Oil prices plummeted this past week on increased concern over recession appearing likely on a global basis. The negative news in the U.S. on Empire State, Philly Fed, Beige Book, retail sales, industrial production, housing starts, and consumer sentiment led traders to conclude that demand for oil is falling back sharply. Adding to that view, the government's weekly inventory report showed a larger-than-expected jump in crude and gas supplies.
The low settle last week for spot West Texas Intermediate was Thursday’s close at $69.85 per barrel – the lowest since mid-August of last year. Prices firmed back over $70 per barrel on Friday on speculation that OPEC will announce production cutbacks at this week’s emergency OPEC meeting. Many OPEC members are concerned about the loss of revenues resulting from the precipitous drop in oil prices.
Net for the week, spot prices for West Texas Intermediate fell further by $5.85 per barrel after the prior week’s decline of $16.18 per barrel. Crude settled for the latest week at $71.85 per barrel – coming in $73.44 below the record settle of $145.29 per barrel set on July 3. This is down 50.5 percent from the peak.
The financial markets in recent weeks have held investors in rapt attention. Meanwhile, economic indicators on various real sectors (outside the financial) have worsened. But headline inflation at the producer and consumer levels has eased.
 The consumer is the backbone of the U.S. economy – contributing some two-thirds to GDP. When the consumer sector stumbles, so does the overall economy. The latest news is not good as retail sales in September came in far worse than expected, indicating that the consumer sector is in retreat. Overall retail sales fell 1.2 percent in September, following a 0.4 percent decline in August. Weakness was led by autos. But even excluding motor vehicles, retail sales declined 0.6 percent in September, after a 0.9 percent drop the month before. Excluding motor vehicles and gasoline, retail sales decreased 0.7 percent, after slipping 0.6 percent the month before.
Components were widely negative. Particularly weak were motor vehicles, down 3.8 percent; furniture, down 2.3 percent; and clothing, down, 2.3 percent. Overall retail sales on a year-on-year basis in September were down 1.0 percent - compared to up 1.5 percent in August.
The September retail sales report shows a consumer sector that has pulled back over concerns over job losses and overall concern for the economy. In turn, consumer sector weakness is likely to pull down the overall economy.
 Not long ago, the big worry for consumers was paying high gasoline and high food costs. Well, the gasoline part has come down significantly and that should have lifted consumer spirits. But now consumers have been rattled by the highly publicized need for financial sector bailouts and by the stock market crash.
Consumer spirits hit record lows early in the summer before firming, but the ongoing financial crisis has pushed readings back down to or near record lows. The University of Michigan/Reuters consumer sentiment index plunged a record 12.8 points from September to a mid-month October reading of 57.5. The current conditions component, at 58.9, is at an all-time low. And these are data going back to the early 1950s. Until consumers come out of defensive mode, there likely is not going to be much cheer in the retail sector as we head into the holiday season.
 The first major sector of the economy to go into decline this business cycle was housing and it continued to plummet in September. Housing starts declined 6.3 percent, following an 8.1 percent fall in August. The September pace of 0.817 million units annualized was down 31.1 percent year-on-year. The pace of starts is the lowest since the 0.798 million units for January 1991. Starts are extremely weak, and it is getting difficult to see them getting much lower. The September pace was 64.1 percent lower than the historical peak of 2.273 million units annualized set in January 2006. The latest drop in starts was led by single-family starts, which fell 12.0 percent, after a 4.0 percent decline in August. Multifamily starts rebounded 7.5, after dropping 16.7 percent in August.
By region, the fall in starts was led by a monthly 20.9 percent decline in the Northeast. Starts in the West also dropped – by 16.8 percent in September. The Midwest and South posted gains of 5.6 percent and 0.5 percent, respectively.
But permits declined sharply in September and do suggest perhaps further weakening in starts. Permits fell 8.3 percent, following a 8.5 percent decrease in August. The September 0.786 million unit pace for permits was down 38.4 percent year-on-year.
The continued weakness in housing is a concern to the overall economy as this sector has lost thousands of relatively high-paid construction jobs. Negative spillover has also been seen in declines in sales and production of construction materials and in household appliances.
 Industrial production in September was down extremely sharply but special factors did play a role. Overall industrial production dropped an unexpectedly sharp 2.8 percent in September, following a 1.0 percent decline in August. The Federal Reserve specifically noted that the decline was due in part to the impact of hurricanes Gustav and Ike and the Boeing strike. Also, the Fed stated that the hurricane effect was about 2-1/4 percentage points and the Boeing strike effect was about 1/2 percentage point. The September decline was the largest since a 3.5 percent drop for December 1974.
The latest report shows that industrial production is about flat after discounting special factors. But outside of the industries affected by the special factors, there were widespread declines with automotive being about the only positive exception. Although the sharp decline for September is not the true trend for industrial production, a weakening economy and negative growth abroad indicate that manufacturing likely is on a moderate downtrend. The latest industry detail suggests that manufacturing is in recession and likely is helping to tug the overall economy into at least a brief contraction if not longer should credit markets fail to improve.
 More current data on the manufacturing sector points to further declines in industrial production. The Empire State manufacturing index plunged more than 17 points to minus 24.6. The machinists strike at Boeing was a special factor but there were indications of overall weakness. Order readings were especially weak with the new orders index at minus 20.5 and unfilled orders at minus 12.2. The news is just as bad for the six month outlook which fell to 24.2 in October from 43.1.
 The mid-Atlantic region’s manufacturing sector took a turn for the worse in October. Alarming declines were reported for a number of key series. The report's headline business activity index plunged to minus 37.5 from plus 3.8 in September for the sharpest one-month drop ever in 40 years of data. Dramatic declines also were seen in new orders, unfilled orders, shipments, workweek, and employment.
In a special question that may unfortunately point to the key reason behind the October plunge, the report said 14 percent of firms reported having difficulty obtaining credit over the past month with 30 percent reporting such problems with their customers.
 During an economic downturn, unexpected gains in inventories can weigh on economic growth as businesses cut back on product stocks to both match demand and reduce the cost of carrying unsold inventories. Currently, businesses are putting the brakes on inventories but it may not be fast enough given the size of the fall in sales. Business inventories rose 0.3 percent in August while business sales fell 1.8 percent, pushing up the stock-to-sales ratio by 3 tenths to 1.27.
Inventories at retailers fell 0.6 percent with inventories at auto dealers, in a real plus, falling 1.6 percent. But dealer inventories, after swelling 3.1 percent in July, are still high, and supply chain problems may yet magnify the effects of the violent downshift underway in auto demand.
Inventories may end up adding to third-quarter GDP but the boost will not be a positive for the economic outlook. Unwanted inventory will weigh on production and, in turn, jobs and income.
 As the Fed has hoped, energy costs are now actually helping inflation to ease as producer price inflation at the headline level continued downward. The overall PPI fell 0.4 percent in September, following a 0.9 percent fall in August.
As in August, energy pulled headline inflation down in September with a 2.9 percent drop after a 4.6 percent drop the prior month. Food price inflation eased to 0.2 percent from 0.3 percent in August.
 In contrast, the core PPI rate rose to 0.4 percent, following a more moderate 0.2 percent gain in August. But the firming was largely due to large monthly swings in car dealership discounting at the producer level. Passenger cars jumped 0.5 percent while light trucks spiked 1.0 percent.
For the overall PPI, the year-on-year rate dropped to up 8.7 percent in September from up 9.7 percent the month before (seasonally adjusted). The core rate jumped to up 4.1 percent from up 3.7 percent in August.
 As with the PPI, consumer price inflation in September came in quite tame - thanks to lower energy and also to a drop in motor vehicle prices. The headline CPI was unchanged, following a 0.1 percent dip the month before. The core rate softened to a 0.1 percent gain in September after rising 0.2 percent the month before. A drop in energy costs - down 1.9 percent for September - was the main factor behind flat headline inflation. Also declining were new & used vehicles and apparel. Car dealerships are still passing out deals to buyers although manufacturers have reduced their rebates. Housing declined but that was due to the energy subcomponent.  In contrast, food costs are still seeing the impact of a higher cost structure as food inflation was unchanged at a high 0.6 percent.
Year-on-year, the overall CPI dropped to up 4.9 percent (seasonally adjusted) in September from 5.4 percent in August. The core rate was unchanged from a 2.5 percent year-ago boost in August.
The bottom line is that inflation is slowing due to lower energy costs and a flat economy and the good news on inflation is giving the Fed room to keep rates low and keep pumping liquidity.
The Federal Reserve's Beige book prepared for the October 29 FOMC meeting reported that the economy continued to weaken in recent weeks while inflation pressures have moderated. The Fed's regional contacts have become "more pessimistic." Perhaps most disconcerting was the Beige Book's statement that "consumer spending decreased in most Districts" with declines seen in retailing, autos, and tourism. The consumer sector is the bulwark of the economy and when the consumer sector declines, it usually takes the rest of the economy with it. Most sectors were reported as weak, including manufacturing, residential real estate, and commercial real estate activity. Positives were mainly limited to agriculture and natural resources.
Contributing to weakening in the economy were "tight" credit conditions across all twelve Fed districts. According to the Beige Book, banks have been more cautious about lending and there were a number of reports from businesses of "difficulties in obtaining credit."
The key positive in the report was that inflation pressures "moderated" a bit in September. Some pass-through was reported for some metals, food, and energy, but most districts reported that cost pressures had eased.
The bottom line is that the latest Beige Book shows the economy likely in contraction with inflation easing but credit tightness remaining a problem.
Some six months ago or so, the big worry about the real sector was housing. Now we are not only seeing further deterioration in housing, but contractions have set in for manufacturing and the retail sector. Even as aggressive actions by the Treasury, Fed, and other central banks will be helping to unfreeze the credit markets, we now have to worry about pulling out of a real contraction – increasingly likely a full-fledged recession. But the inflation outlook has improved and that gives the Fed more near-term flexibility.
This coming week is extremely light on economic indicators with only a few second tier releases – no market moving indicators. We will get another update on whether the economy is getting closer to meeting the technical definition of recession with the Monday release of leading indicators. That report also includes coincident indicators – the series that primarily defines recession and recovery. There will be a housing update on Friday with existing home sales numbers.
The Conference Board's index of leading indicators is now pointing to possible recession in the fourth quarter, although it is still a tossup whether the coincident index will be revised to push any official start of recession back into the third quarter. The index of leading economic indicators fell a steep 0.5 percent in August on top of July's even steeper 0.7 decline. The index of coincident economic indicators, designed to peg current activity, slipped only very slightly by 0.1 percent and follows a no-change reading in July. But downward revisions to the coincident index could lead to recession having begun in the third quarter.
Leading indicators Consensus Forecast for September 08: -0.2 percent
Range: -1.0 to +0.5 percent
Initial jobless claims for the week ending October 11 fell back a sizable 16,000 to 461,000 despite continued hurricane effects. In contrast, continuing claims were at their highest since 2003, up 40,000 in the October 4 week to 3.711 million. The good news is that there was a pause in the worsening job market with the latest initial claims. But the good news is likely to be short-lived given the broadening of economic weakness across an increasing number of sectors.
Jobless Claims Consensus Forecast for 11/18/08: 470,000
Range: 450,000 to 490,000
Existing home sales fell 2.2 percent in August to a 4.910 million unit rate. Condo sales dropped 8.2 percent while single-family home sales fell a less alarming 1.4 percent. The year-on-year rate, helped by continually declining baselines for the year-ago level, is less frightening at minus 10.7 percent in August for the least severe dip since July 2007. Supply – while still excessive – is beginning to ease off its worst overhang. Months’ supply edged down to 10.4 months in August from 10.9 months in July. Prices have been in nearly uninterrupted decline for two years with August posting a 3.4 percent drop to $203,100 and a year-ago decline of 9.5 percent. But given the 7.4 percent jump in pending home sales for August, we may see a rebound in existing sales in September.
Existing home sales Consensus Forecast for September 08: 4.92 million-unit rate
Range: 4.70 to 5.11 million-unit rate
Econoday Senior Writer Mark Pender contributed to this article.
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