The economy has now moved into another phase.  Certainly, the economy is in recession. Housing and manufacturing have been declining for some time.  But the past week confirmed that the consumer sector is now in contraction also.  With job losses accelerating, unemployment spiking, and debt high, the consumer has pulled out the shovel and is digging a deep fox hole to weather the economic fire.

Recap of US Markets

STOCKS

Stocks were down net for the past week.  Notably, the week was quite volatile with a new intraday low being set by the Dow on Wednesday—only to see a huge surge on Thursday and retreat on Friday.

The bottom line is that all sectors are being hit.  But some of the most worrisome news came out Friday morning as key retailers announced quarterly results.  But what stood out were the reductions to guidance.  Retailers lowering guidance sharply were Nordstrom, Kohl’s, Abercrombie, and JC Penney.  But the high end stores were hit the hardest.  Also, Best Buy, the nation’s largest electronics retailer, lowered guidance, calling the current environment the most difficult the company has ever seen.  The main point is that the consumer sector is likely to be weak for some time.

Lower oil prices pulled the energy sector down.  Utilities declined despite lower energy costs because of the view that demand is falling sharply. 

Of course, continued talk of a possible General Motors bankruptcy weighed on markets.  Treasury Secretary Henry Paulson’s announcement of changing the TARP focus from buying troubled mortgage back securities to propping up the consumer sector somewhat unnerved investors.  The change in focus was not the issue but rather the increased likelihood that the Treasury and Fed were groping around for a solution to credit market problems instead of having a convincing resolution underway.

Early in the week, China announced plans to implement a stimulus program to help its economy. Stocks overseas reacted positively but by close in the U.S., investors had decided any stimulus package would be very slow in coming.

Financials were hard hit during the week on concern over the worsening consumer sector, layoffs in the financial sector, the Treasury Department’s scrapping its plan to buy mortgage backed assets, and over some tightening in credit markets as indicated by a higher TED spread and VIX index.  It should be noted that the financial world as the U.S. knows it came to and end this past week as the Fed approved a request by American Express to become a bank holding company.  The AmEx move gives it better access to Fed credit facilities and to capital from consumer deposit accounts.

Equities were down this past week. The Dow was down 5.0 percent; the S&P 500, down 6.2 percent; the Nasdaq, down 7.9 percent; and the Russell 2000, down 9.7 percent.

For the year-to-date, major indexes are down as follows: the Dow, down 35.9 percent; the S&P 500, down 40.5 percent; the Nasdaq, down 42.8 percent; and the Russell 2000, down 40.4 percent.

Markets at a Glance

Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.

BONDS

Treasury yields ended this past week down—especially for mid-range notes.  Yields were down in three of the four trading days in the week shortend in the bond pits by Veterans Day.  Rates fell notably on Wednesday and Friday.  Flight to quality was heavy on both days as Treasury Secretary Henry Paulson announced on Wednesday a change in focus on his financial rescue plan—TARP.  The Troubled Asset Relief Program will now focus on helping the consumer credit sector rather than buying troubled mortgage asset backed securities.  The unexpected change in focus led many market participants to conclude that the financial rescue plan is uncertain and not in clear focus—that is, likely not as effective as proviously hoped.  Also rattling the bond markets was talk of a very possible General Motors bankruptcy.

Recession worries returned to the forefront on Friday after a dismal retail sales report, a spike in unemployment claims on Thursday, and on the markets concluding that the upcoming G-20 round of economic talks will not likely produce any results anytime soon. 

Heightened concerns about the private segments of the credit markets led to a decline on the short end to miniscule rates of return.  The 3-month T-bill ended last week at 0.13 percent.

For this past week Treasury rates were down as follows: 3-month T-bill, down 15 basis points, the 2-year note, down 14 basis points; the 5-year note, down 26 basis points; the 10-year bond, down 7 basis points; and the 30-year bond, down 4 basis points.

OIL PRICES

Crude oil prices continued to spiral downward on a drop in demand.  However, prices actually firmed at the start of the week on news that China is working on a fiscal stimulus plan for its economy.

But the bump up was short-lived as prices fell over $3 per barrel on both Tuesday and Wednesday for West Texas Intermediate.  Leading prices down were heightened concern about a possible GM bankruptcy further damaging the economy and a rise in the dollar.  Also, skepticism grew about how quickly China’s possible stimulus plan might take to implement. Finally, prices were weighed down on Wednesday on fears that crude supplies would be up for the week.  The petroleum report was delayed until Thursday because of the Veterans Day holiday.

Prices firmed on Thursday as crude supplies were steady as opposed to the expected rise.  But the drop  in retail sales on Friday reminded traders that demand remains weak and crude ended the week on a down note.  The price of crude settled below $60 per barrel each of the last four days of this past week.  Overall, market focus is on global recession and falling demand.

Net for the week, spot prices for West Texas Intermediate dropped $3.60 per barrel to settle at $57.44 – and coming in $87.85 below the record settle of $145.29 per barrel set on July 3.

The Economy

The economy is being tugged further down by a retrenching consumer sector.  Retail sales have declined for four consecutive months and the consumer does not appear to be in a mood to turn the economy around any time soon.

Consumer spending falls back

The consumer sector is the backbone of the U.S. economy with consumer spending typically making up about two-thirds of GDP. But there are signs that the consumer sector is not only no longer supporting growth but is actually contributing to negative growth. Retail sales in October showed the consumer continuing to retreat. Weakness was led by gasoline and autos but declines were widespread. Overall retail sales dropped another 2.8 percent in October, following a 1.3 percent fall in September. The latest decline is the worst on record since this series began in 1992.

Declines were widespread. The largest drop was for gasoline sales—which fell 12.7 percent on lower prices and lower demand. Motor vehicles also dropped a sizeable 5.5 percent. Declines were also seen in furniture, electronics & appliances, building materials & garden equipment, clothing, sporting goods, general merchandise, and nonstore retailers.

Gains were hard to find. By major category, only miscellaneous store retailers and food services & drinking places posted increases. Food & beverage store sales were flat.

Not only are current retail sales anemic but consumer sentiment remains historically low, suggesting that improvement in sales is not coming any time soon.

Neither the conclusion of the presidential election nor lower gasoline prices did much to offset consumer worries about the economy. Consumer sentiment in early November barely edged above the near record low of 57.6 in October—rising to 57.9.  The expectations reading, which often leads the overall index, is not pointing to any improvement. The consumer does not appear to be in the mood to do any heavy lifting for the economy.

The credit crunch, job losses, and fears of further layoffs are causing consumers to hang on to their cash. If October and early November data are signs of the future, the consumer sector does not appear likely to be doing much to spur economic growth in coming months.  And this week’s lowered guidance on revenues by key retailers confirms that businesses are starting to come to terms with a consumer sector in recession.

Trade gap narrows but hides ugly news

One typically expects that a narrowing in the trade deficit would be something to be excited about.  The smaller gap means less drain on the economy and more stimulus, right' Well, it all depends on how you get there and the September trade numbers clearly had some negative implications for economic growth in coming months.

The good news is that the overall U.S. trade gap shrank further to $56.5 billion from a revised $59.1 billion deficit in August. But the component export and import changes hint at problems ahead. In September, exports fell 1.7 percent while the larger imports component declined 2.2 percent. The overall improvement was largely seen in a smaller oil deficit which narrowed--to $32.1 billion from $35.6 billion in August. Once again, lower oil prices had a key role in shrinking the oil deficit. The average price of imported oil declined to $107.58 per barrel in September from $119.99 per barrel in August.

However, the nonoil goods deficit widened on the drop in exports—to $35.6 billion from $33.7 billion in August. The September decline in exports of goods was seen in all major end-use categories but was led by a $4.2 billion fall in capital goods and a $4.1 billion drop in industrial supplies. 

Weaker and even negative growth abroad and a stronger dollar point to slower growth or even declining exports for U.S. manufacturers in the near future.  While consumers and businesses are getting a lift from lower oil prices, manufacturers will be taking a hit from slower growth or a decline in exports.

Import prices fall on lower oil prices and lower economic growth

The growing global recession is having a profound impact on import prices. Import prices fell 4.7 percent in October, following a 3.3 percent drop in September. Year-on-year rates have slowed sharply—to up 6.7 percent for overall import prices and down from a record peak of up 21.5 percent in July.

Import prices have been pulled down by lower oil prices, which fell 16.7 percent in September after a 10.2 percent decrease the month before.  Even non-petroleum import prices have been on a downtrend, falling for three consecutive months.  Non-petroleum import prices declined 0.9 percent in both October and September.

Leading non-petroleum prices down in the latest month were non-petroleum industrial supplies (such as finished and unfinished metals, building materials, and nondurable supplies & materials).  Foods, feeds & beverages also fell—for the second consecutive month.  The capital goods component edged down 0.2 percent in October after being flat the prior two months.

Even the major components that rose were soft. Automotive import prices firmed 0.1 percent in the latest month as did consumer goods excluding autos.

The bottom line is that slowing demand world-wide and a stronger dollar are leading to softer import prices which, in turn, are helping to ease U.S. inflation. The slower inflation numbers will make it easier for the Fed to continue accommodative monetary policy in the near-term.

The bottom line

The consumer sector is pulling back and this is bad news for the overall economy.  Not only are housing and manufacturing weak, but now the biggest sector of the economy has joined the downturn.  In terms of getting the economy back on an uptrend, monetary policy is about as loose as possible.  Clearly, the Fed will continue to work to improve lending in the credit markets.  But lower interest rates and improved credit conditions are going to take time to spur the economy.  An additional round of fiscal stimulus might help but the lag in time needed to implement is not favorable.  The economy is likely to be in negative growth at least through the first quarter of 2009.  Even if positive growth starts in the spring, it is not likely to be very robust.

Looking Ahead: Week of November 17 through 21 

This coming week, market moving indicators focus on manufacturing, housing, and inflation with releases for industrial production, housing starts, the producer price index, and the consumer price index.  Also, markets will be going over the minutes of the October 28-29 FOMC meeting with a fine-toothed comb after their release Wednesday afternoon.

Monday 

The Empire State manufacturing index contracted sharply in October, plunging more than 17 points to minus 24.6. While the strike at Boeing played a role in the decline, overall economic weakness was the general theme.  Looking ahead, the new orders index is an ill omen as it came in at minus 20.5 and unfilled orders were minus 12.2. At least cost pressures eased significantly. The prices paid index fell to 31.7 in October from 44.8 the previous month while the prices received index declined to 20.7 from 24.1.

Empire State Manufacturing Survey Consensus Forecast for November 08: -26.0

Range: -40.0 to -14.0

Industrial production in September was down extremely sharply but special factors played a role. Overall industrial production dropped an unexpectedly sharp 2.8 percent in September, following a 1.0 percent decline in August. The latest decline was due in part to the impact of hurricanes Gustav and Ike and the Boeing strike. The Fed stated in its report that the hurricane effect was about 2-1/4 percentage points and the Boeing strike effect was about 1/2 percentage point.  By major components, manufacturing fell 2.6 percent in September while utilities output rose 2.2 percent and mining output dropped a dramatic 7.8 percent (reflecting oil rig shutdowns in the Gulf of Mexico). Overall capacity utilization in September fell to 76.4 percent from 78.7percent in August.  Looking ahead, according to the employment report, aggregate hours worked in manufacturing dropped 1.0 in October—suggesting a strong decline for at least the manufacturing component in industrial production.  Also, the Philly Fed and New York Fed manufacturing indexes showed significant worsening in October.  But a sharp rebound in aircraft production and resumption of oil production in the Gulf could temporarily put overall production in positive territory.

Industrial production Consensus Forecast for October: +0.2 percent

Range: -3.0 to +2.0 percent

Capacity utilization Consensus Forecast for October 08: 76.4 percent

Range: 75.5 to 77.7 percent

Tuesday

The producer price index for September at the headline level continued downward due another drop in energy costs. Core inflation, however, rebounded. The overall PPI fell 0.4 percent, following a 0.9 percent fall in August. In contrast, the core PPI rate rose to 0.4 percent, following a more moderate 0.2 percent gain in August. The September core topped the market forecast for a 0.2 percent increase. The core was led by a rebound in prices for cars and trucks but other components also showed a firming in price pressure.  We are likely to see further PPI weakness in October at the headline level due to the continued drop in oil and other commodity prices. The core also should soften as auto dealers have had a sharp decline in sales and there likely will be some reversal in motor vehicle prices from the September price increases.

PPI Consensus Forecast for October 08, m/m: -1.7 percent

Range: -2.8 to -0.3 percent

PPI Consensus Forecast for October 08, y/y: +6.0 percent

Range: +5.4 to +7.8 percent

PPI ex food & energy Consensus Forecast for October 08, m/m: +0.1 percent

Range: -0.3 to +0.3 percent

PPI ex food & energy Consensus Forecast for October 08, y/y: +4.0 percent

Range: +3.6 to +4.3 percent

Wednesday

The consumer price index in September came in quite tame - thanks to lower energy and 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. 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. We can expect another low headline number for October thanks to declining energy costs. Also, with retail sales so weak, retailers are likely discounting more and that likely will show up in the core number.

CPI Consensus Forecast for October 08, m/m: -0.7 percent

Range: -1.4 to -0.1 percent

CPI Consensus Forecast for October 08, y/y: +4.0 percent

Range: +3.2 to +4.9 percent

CPI ex food & energy Consensus Forecast for October 08, m/m: +0.1 percent

Range: 0.0 to +0.3 percent

CPI ex food & energy Consensus Forecast for October 08, y/y: +2.4 percent

Range: +2.2 to +2.6 percent

Housing starts in September continued to plummet, dropping 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. Many traders hope that starts have hit bottom and will start heading back up, albeit slowly. But housing sales have not picked up enough for any sustained rebound in starts.  Both new and existing homes for sale inventories remain very high.  Also, the household sector is in less position to buy—there is no reason for homebuilders to be optimistic.  Job losses have accelerated and the unemployment rate has spiked. Any given month, starts can show unexpected life, but the fundamentals for housing have worsened, not improved.  Any rise in starts should be discounted as not sustainable.

Housing starts Consensus Forecast for October 08: 0.780 million-unit rate

Range: 0.740 million to 0.870 million-unit rate

The Minutes of the October 28-29 FOMC meeting are scheduled for release at 2:15 p.m. ET.  Several Fed officials have hinted that the door is not closed for further rate cuts even though the fed funds target rate is now matching the previous cycle low of 1 percent.  Bond and futures markets have baked in a 50 basis point cut at the upcoming December 16 FOMC meeting.  But count on the markets parsing the minutes for any signs of reluctance for further rate cuts by some of the traditionally more hawkish regional Fed presidents.

Thursday

Initial jobless claims for the November 8 week jumped 32,000 to 516,000 for a seven-year high.  There now is no doubt that the labor market is in a full-fledged recession.  Not only are new claims spiking, but those already picking up unemployment checks are having difficulty finding a new job.  Continuing claims for the November 1 week jumped 65,000 to 3.897 million for a 25-year high.  These trends are likely to continue or worsen as recent manufacturing surveys point to worsening employment conditions.

Jobless Claims Consensus Forecast for 11/15/08: 505,000

Range: 480,000 to 525,000

The Conference Board's index of leading indicators unexpectedly rose 0.3 percent in September, but followed a very steep decline of 0.9 percent in August and a 0.7 percent drop in July. The largest factor by far adding to September's gain was the Fed’s pumping up liquidity as the money supply component added 0.45 percentage points to the leading index’s monthly change — meaning the overall index would have fallen 0.2 percent without the surge in money supply.  There is a good chance the leading index will resume its fall in October, especially given the further weakening in stocks and decline in housing permits.  The S&P 500 dropped 16.9 percent in October, month-end over month=end, while the initial estimate for housing permits fell 8.5 percent.

Leading indicators Consensus Forecast for October 08: -0.6 percent

Range: -1.2 to -0.2 percent

The general business conditions component of the Philadelphia Fed's business outlook survey index has shown some of the weakest conditions for manufacturing in the country. 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.  Not surprisingly, prices softened significantly.  The prices paid index fell to 7.2 in October from 31.5 in September while the prices received index slipped to 5.3 from 15.5.

Philadelphia Fed survey Consensus Forecast for November 08: -35.0

Range: -45.0 to -24.8

Econoday Senior Writer Mark Pender contributed to this article.