By Evelina M. Tainer, Chief Economist, Econoday
May 27, 2005
Recap of US Markets
STOCKS
Stock prices didn't do much on Friday, but the week's gain was solid. Wednesday was not a stellar day for stocks due to a spurt in oil prices. Yet, oil prices were generally rising over the course of the week - and they didn't seem to impact equity prices on days in which other more friendly news was available. For instance, the Commerce Department reported an upward revision to first quarter GDP on Thursday - along with robust news on corporate profits. While all major stock indexes remain below levels posted on December 31, 2004, the S&P 500 is only 1.1 percent below its level and the Dow Jones Industrials are 2.2 percent below year-end. A couple more weeks like the ones we just had could boost these two indexes over to the plus column. The Nasdaq composite and the Russell 2000 have a little further to go.
BONDS
Today's yield curve, with the 3-month bill at 2.95 percent at the 30-year bond at 4.43 percent, is not very different than the yield curve posted four weeks ago, just before the Federal Reserve increased the funds rate target by 25 basis points, bringing it to 3 percent. One would certainly expect higher yields today. Yet, four weeks later, we now see slightly lower yields for 5-year and 10-year notes and 30-year bonds.
Speaking today in Seoul before a Bank of Korea conference, San Francisco Fed president Janet Yellen once again reiterated that low long rates are a conundrum even after one takes into account the globalization of markets and the heavy concentration of Asian buying (of U.S. securities).
Yellen believes that greater transparency by the Fed would improve the effectiveness of policymaking and is in favor of inflation targeting. However, she would prefer to not have a strict index number that needs to be targeted in a limited band, but one with flexibility.
Yellen admitted that it is difficult to measure just how much globalization and Asian purchases of U.S. securities are impacting the market. However, judging by the fact that 30-year bond yields are now roughly 100 basis points lower than they were a year ago, one would have to believe that a good portion of that yield differential must be due to globalization.
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.
The Economy
Q1 GDP revised higher
The Commerce Department's revised estimate revealed that real GDP grew at a 3.5 percent rate in the first quarter, a moderate upward adjustment from the advance report that showed a 3.1 percent growth rate for the period. More significant, however, is the sharp upward revision in real final sales, which grew at a 2.7 percent rate rather than the initially estimated 1.9 percent pace. This still reflects solid inventory building in the first quarter, and slower final demand than 2004's second half when real final sales increased at a robust 4.2 percent rate. Nonetheless, it suggests slightly more upbeat economic activity than initially reported.
Real personal consumption expenditures were roughly unchanged from last month's estimate, growing at a 3.6 percent rate, a slower pace than in the second half of 2004 when consumer spending jumped at a 4.7 percent rate. A moderation in durable goods expenditures (fewer motor vehicle sales) is primarily behind the slowdown.
Nonresidential fixed investment increased at a meager 3.5 percent rate in the first quarter, down from the second half of 2004's 13.8 percent pace. Spending on structures declined, but even spending on equipment and software fell back to a 5.6 percent rate after growing at an 18 percent rate in last year's second half. In contrast, spending on residential investment accelerated in the first quarter, to an 8.8 percent rate after a meager 2.5 percent pace in 2004's second half.
To no one's surprise, net exports deteriorated, but import growth was not as strong as originally estimated, so real net exports acted as a smaller drag on domestic growth in the first quarter than initially reported.
All in all, the GDP figures were relatively solid, but the moderation in final sales coupled with a big inventory build-up suggests that demand weakened, and the "soft patch" may continue.
Corporate profits jump
After several quarters of moderate growth, after tax profits surged in the first quarter, rising more than 36 percent from last year's first quarter. This was the largest year-over-year growth since the fourth quarter of 1987! These healthy profit figures certainly support moderately healthy gains in stock prices such as we've seen in the past few weeks. Although, it is well to remember that market players are forward-looking and would want evidence of equally strong profits throughout the year for a sustained upward movement in stock prices.
Housing spurt
Existing home sales jumped 4.5 percent in April to a 7.18 million-unit rate while new single-family home sales inched up 0.2 percent during the month to a 1.32 million-unit rate. As a result, total home sales reached, yet again, a new peak. Mortgage rates in March and April were higher than the past several months, but still below 6 percent - and low by historical standards.
Paul Krugman, an economist and columnist for The New York Times addressed the issue of housing bubbles today. Until now, he was not entirely convinced that a housing bubble was in place. But more and more evidence is beginning to support this view. The National Association of Realtors estimates that 23 percent of last year's home sales were purchased for investment rather than owner-occupied housing. And Business Week notes that 31 percent of new mortgages are interest-only. (The New York Times, May 27, 2005.)
This sounds like the stage immediately preceding the 2000 stock market crash when investors were happily buying overpriced stocks on margin. And it is always dangerous when everyone believes something (stocks, gold, tulips, real estate) is a good investment.
April durable goods orders rise, but aren't looking great overall
New orders for durable goods jumped 1.9 percent in April, but this merely recovers March's 1.6 percent drop and February's 0.1 percent dip. In the first four months of this year, new orders are averaging monthly declines of 0.3 percent! This is not a good start to the new year and does not bode well for healthy gains in industrial production over the next few months.
Without the benefit of sharp increases in aircraft orders, orders were anemic. New orders excluding transportation dipped 0.2 percent in April. While new orders for fabricated metals and machinery helped to lift durable goods, they were overcome by an 18.8 percent drop in communications equipment. Also, new orders for primary metals fell.
Notice that the longer-term trends in new orders have shown significant moderation lately. Whether or not new orders drop sharply below zero, or hover near the zero line, there is no question that manufacturing activity looks more anemic these days. We have seen slowdowns, even recessions, in manufacturing while the rest of the economy continued to grow. This was the case in 1998-99.
The Bottom Line
Is there no end in sight to the housing market boom' Judging by the number of articles commenting on housing bubbles, one would think that the end is near. While low interest rates certainly help buyers, the rapid appreciation in housing will simply price many potential buyers out of the market.
First quarter GDP growth was better than initially estimated and after tax corporate profits posted extraordinary growth. This should bode well for stock prices - if it continues. Equity investors look towards future profit prospects.
The upcoming week is filled to the brim with key economic indicators such as the ISM surveys and the May employment situation.
Looking Ahead: Week of May 30 to June 3
Tuesday
The Conference Board's consumer confidence index fell more than 5 points in April to 97.7. This was the third straight drop after the index reached a near term peak in January. Accelerating inflation without healthy labor market improvement could continue to dampen consumer confidence.
Consumer confidence Consensus Forecast for May 05: 96
Range: 95 to 100
The NAPM-Chicago's business barometer fell back in April to 65.6. This index, which measures both manufacturing and non-manufacturing activity in the Chicago region, was still strong for the month. It remains to be seen whether activity remained healthy in May given that two key Fed surveys (Philly Fed and Empire State) declined in May.
NAPM-Chicago Consensus Forecast for May 05: 60.3
Range: 58 to 65
Wednesday
The ISM manufacturing index dipped to 53.3 in April after posting stronger activity in the six previous months. Two key Fed surveys in the Mid-Atlantic regions posted declines in May; perhaps the ISM survey will follow suit.
ISM manufacturing index Consensus Forecast for May 05: 52
Range: 51 to 55
Construction spending increased 0.5 percent in March. Housing starts improved in the past three months and this could help boost construction expenditures in upcoming months. In addition, we could see increases in nonresidential spending as well.
Construction spending Consensus Forecast for Apr 05: 0.6 percent
Range: 0.4 to 2.0 percent
Motor vehicle sales increased 3 percent in April to a 13.9 million-unit rate with sales rising for both light trucks and autos. Autos sold at a 5.8 million-unit rate while light trucks sold at an 8.1 million-unit rate during the month. With high gasoline prices, one would expect improved sales gains for cars and fewer purchases of gas-guzzling SUVs.
Auto sales Consensus Forecast for May 05: 5.7 million-unit rate
Range: 5.6 to 5.8 million-unit rate
Light truck sales Consensus Forecast for May 05: 7.8 million-unit rate
Range: 7.8 to 8.0 million-unit rate
Thursday
New jobless claims inched up 1,000 in the week ended May 21 to 323,000. The four-week moving average was virtually unchanged at 330,500 for the week. The average level of claims for the three weeks of May is up moderately from the April monthly average.
Jobless Claims Consensus Forecast for 5/21/05: 325,000 (2,000)
Range: 315,000 to 330,000
Nonfarm productivity rose at a 2.6 percent rate in the first quarter, slightly faster than in the fourth quarter of last year. The upward revision to GDP growth in the first quarter could point to faster productivity growth for the period. The initial estimate showed that unit labor costs increased at a 2.2 percent rate in the first quarter, but faster productivity growth is often accompanied by slower growth in unit labor costs.
Nonfarm productivity Consensus Forecast for Q1 05: 3 percent rate
Range: 2.3 to 3.1 percent rate
Unit labor costs Consensus Forecast for Q1 05: 2.5 percent rate
Range: 1.2 to 3.5 percent rate
Factory orders inched up a mere 0.1 percent in March, but with the 1.9 percent in durable goods orders in April, will likely post a stronger gain. Orders are benefiting from a spurt in Boeing orders in recent months.
Factory orders Consensus Forecast for Apr 05: 1.2 percent
Range: 0.6 to 1.8 percent
Friday
Nonfarm payroll employment jumped 274,000 in April, more than expected and a relatively healthy pace in light of recent sluggish gains. The civilian unemployment rate remained unchanged at 5.2 percent in April.
Nonfarm payrolls Consensus Forecast for May 05: 190,000
Range: 140,000 to 240,000
Unemployment rate Consensus Forecast for May 05: 5.2 percent
Range: 5.1 to 5.3 percent
Average workweek Consensus Forecast for May 05: 33.8 hours
Range: 33.7 to 34 hours
Average hourly earnings Consensus Forecast for May 05: 0.2 percent
Range: 0.1 to 0.3 percent
The business activity index from the ISM non-manufacturing survey fell back to 61.7 in April. Manufacturing activity has moderated more sharply in May, but we haven't yet seen any figures on the non-manufacturing sector.
Business activity index Consensus Forecast for May 05: 61
Range: 58 to 62.5
Another good week for stocks