STOCKS
Equities started the week slowly with only a modest downturn on Monday as investors generally were waiting on a number of market moving economic indicators later in the week. The misinformation regarding former Fed Chairman Alan Greenspan making recession talk began making the rounds and unsettling the markets. The 8 percent drop in the Shanghai market on Tuesday further prepped U.S. markets for a correction. Finally, Tuesday morning's bigger-than-expected drop in durable goods orders was the final factor causing U.S. stocks to take a dive Tuesday. Improvement in existing home sales and the Conference Board's consumer confidence index did little to slow the drop in equities. Wednesday brought out the bargain hunters as GDP came in with downward revisions as expected. The bargain hunters nudged equities back up despite a 16.6 percent drop in new home sales being released Wednesday. Greenspan's clarification commentary also helped somewhat. By Thursday nonetheless, markets had talked themselves into believing that the economy was slowing too much and that interest rate cuts by the Fed were needed and were likely. But when the personal income report came out Thursday with income growth robust and core PCE inflation rebounding, equity markets saw any immediate Fed easing slip away. However, a moderately favorable ISM manufacturing report on later Thursday morning helped stabilize the markets - helping to partially erase memories of the bad report on durables orders.

Last week, the Dow was down 4.3 percent; the S&P 500, down 4.5 percent; the Nasdaq, down 6.0 percent; and the Russell 2000, down, 6.3 percent.

Year-to-date, the Dow is down 2.8 percent; the S&P500, down 2.2 percent; the Nasdaq, down 2.0 percent; and the Russell 2000 is down 1.6 percent.

Major indexes were down over the month of February - although weakness was primarily the last week of the month - notably on the 27th.

BONDS
The bond market got quite a lift from recession talk, weak durables orders, and flight to safety from equities in the U.S. and from abroad. It really was not more complicated than that during last week. On Tuesday, the Greenspan recession flap and the drop in durables orders were responsible for the biggest boost in bond prices last week as rates fell 11 to 18 basis points. Rates rebounded slightly on Wednesday but slipped back down on Thursday and continued Friday.

Net for the week the Treasury yield curve is down sharply. Yields are down as follows: 3-month T-bill, down 7 basis points; 2-year Treasury note, down 26 basis points; 3-year, down 25 basis points; 5-year, down 22 basis points; the 10-year bond, down 17 basis points; and the 30-year bond, down 14 basis points.

Rates declined significantly last week, adding to the downtrend in effect since late January.

Markets at a Glance

The Economy
Last week the markets were rocked by weak economic reports early in the week but later were partially soothed by healthier economic reports. Yet, the week ended with many sharing the view that a shift had occurred in the economy and that it is weaker than believed the prior week. A closer look at the data - or even just a recap of the highlights - suggests that basic trends remain essentially intact. While the first quarter may be a little soft, there are no imbalances to lead to even weaker growth.

Durables goods orders fall
The earth shaker last week was the durable goods report. Durable goods orders fell 7.8 percent in January, following a 2.8 percent boost in December. January's figure was sharply below the consensus forecast for a 3.0 percent drop in new durables orders. Not surprisingly, the January decline was led by a drop in the transportation component. Excluding the volatile transportation component, new orders still fell 3.1 percent, following a 2.6 percent advance in December.

What is important is to keep in mind is that durables orders are very volatile - even during strong recoveries. During periods of moderating growth, swings in orders between positive and negative are not unusual. Are there any imbalances in the economy to suggest that manufacturing is on the way down more than an occasional month or two' Businesses are still flush with cash and while equipment investment may moderate, investment will still be healthy over the course of the year. Recent inventory numbers indicate that there is no notable overhang. As we discuss further below, the consumer is still strong. So, the only case for manufacturing that holds water is that it is moderating and that orders are volatile - no real news if you are paying attention to underlying fundamentals.

Homes sales come in mixed last week
The housing sector is still seen as the primary soft spot in the economy and as one that could have spillover effects on the consumer. Given the sizeable declines in activity the last six to nine months, many are hoping for a bottoming shortly. The jury is still out on that. For January, existing home sales posted a moderate gain while new home sales posted a sharp decline. Existing home sales rose 3 percent in January, to an annual rate of 6.46 million. Supply of unsold homes held steady at 6.6 months but is down from 7.3 months in November.

In contrast, new home sales fell sharply in January, down 16.6 percent to an annual rate of 937,000 units the lowest rate in four years. Supply rose sharply to 6.8 months at the current sales rate vs. 5.7 months in December. Weather played an uncertain role in January, which saw early warmth followed by heavy wintry conditions at month-end.

Which report is more correct' Well, the safe bet is that we cannot rely much on housing data during the winter months when seasonal adjustment factors create more volatility than during the rest of the year. Given the recent downtrend in mortgage rates and the healthy consumer sector, housing is likely near or at bottom.

Fourth quarter GDP revised down sharply
Fourth quarter GDP was revised last week. What can we learn by looking in the rear view mirror at dated economic data' A comparison with growth to potential growth is a key issue. Also, the composition of GDP gives insight into any imbalances in the economy. Fourth quarter real GDP was revised down to an annualized 2.2 percent from the initial estimate of 3.5 percent. The downward revision was primarily due downward revisions to inventory investment and business fixed investment. Importantly, the downward revision puts the fourth quarter well below the 3 percent figure believed by many economists to be long-term potential. The Fed is counting on economic growth below potential to pull inflation down to an acceptable pace. The latest revision to GDP gives the Fed greater reason to believe that the soft landing is on track.

The biggest revision to fourth quarter GDP was for lower inventory investment. Inventory investment was revised down from plus $35.3 billion to plus $17.3 billion. This means less inventory overhang and that any downturn in manufacturing (which is not certain) would be short and shallow. Real final sales posted a robust gain of 3.6 percent, following an increase of 1.9 percent in the third quarter.

Personal income and spending up
The personal income report provided key insight into the health of the consumer sector and the economy and into likely Fed thinking on inflation. Personal income jumped 1.0 percent in January, following a 0.5 percent boost in December. Also, the wages & salaries component increased 1.2 percent, following a 0.5 percent jump in December - although a good part of the boost was from first-of-the-year bonuses, exercise of stock options, and government pay raises that are difficult to seasonally adjust.

The trend in personal income remains quite robust with income up 5.3 percent year-on-year, compared to up 5.6 percent in December. Consumer spending remains quite healthy as personal consumption expenditures advanced 0.5 percent, following a 0.7 percent increase in December.

The bottom line from the consumer perspective is that the economy remains healthy - and not by a small margin.

The moderately bad news is on the inflation front. While the overall PCE deflator rose 0.2 percent in January, the core PCE price index (excluding food and energy) firmed with a 0.3 percent increase in January. The core PCE price index had risen 0.1 percent in the prior three months.

On a year-on-year basis, the overall PCE deflator is up 5.5 percent in January, compared to up 5.9 percent in December. On a year-on-year basis, the core deflator edged back up to up 2.3 percent from up 2.2 percent in December. These numbers are going to keep the Fed on hold for a while before cutting interest rates.

Motor vehicle sales hold up - another positive for the consumer and manufacturing
Vehicle sales held up in February at a combined 12.6 million annual rate equaling January's elevated sales pace. The two more recent months are well up from depressed levels in November and October. The February motor vehicle numbers indicate that auto makers have been working down inventories and that production should be picking up.

Purchasing managers come in mixed
The Chicago Purchasers' index slipped to 47.9 in February from 48.8 in January - negative but near flat reading. In contrast to others data, the Chicago report indicated a rise in inventories.

However, the ISM manufacturing index for the nation firmed to 52.3 in February from 49.3 in January. New orders showed particular strength, rising to 54.9 from 50.3 in January.

Basically, more recent data show a manufacturing sector that is flat to slightly positive and generally with few inventory problems. More recent data certainly do not point to weakness as some extrapolate from January durables orders.

Fed funds futures sees Fed cutting rates by end of June
Last week saw a sharp shift in views by those trading in fed funds futures on when the Fed will begin to cut interest rates. According to fed funds futures there is a little better than 50 percent chance for a 25 basis point cut at the end of June and another 25 basis point cut by the end of December. For some time, however, the bond market and the fed funds futures market have tended to be more pessimistic about the economy than equity markets.

The bottom line
A careful review of last week's data shows only marginal changes in the direction of the economy. In summary:

• Manufacturing is nowhere nearly as weak as some believe new orders suggest. Inventory investment is down, leaving little overhang. Newer survey data show soft manufacturing but not manufacturing in recession.
• Housing is mixed and data are not reliable during winter months.
• The consumer sector is quite robust and will provide key support for manufacturing.
• Core inflation is still too high and the Fed will see inflation as a greater risk than too weak growth.
• Recession is nowhere on the horizon. We are likely to get a soft first quarter but then see better growth the rest of the year.

Looking Ahead: Week of March 5 through March 9
Looking ahead, the economic highlights will come on Friday with the February employment report. Also, the Fed will be releasing the Beige Book on Wednesday afternoon.

Monday
The business activity index from the ISM non-manufacturing survey jumped in January to 59.0 from 56.7 in December. However, sub-indexes suggest a waning in forward momentum as new orders remained slightly in positive territory while backlogs were just into negative territory.

Business activity index Consensus Forecast for February 07: 57.5
Range: 50.5 to 59.5

Tuesday
Nonfarm productivity for the initial estimate for the fourth quarter was up a sharp 3.0 percent compared to a 0.1 decline in the third quarter. Since the last release, fourth quarter real GDP was revised down sharply from an initial 3.5 percent boost to a 2.2 percent increase. Much of the same data that go into real GDP also go into the output portion of production and a significant downward revision is almost certain. Similarly, unit labor costs are likely to be revised up from the initial estimate for the fourth quarter of an annualized 1.7 percent.

Nonfarm Productivity Consensus Forecast for revised Q4 06: 1.6 percent
Range: 1.0 to 2.1 percent

Unit Labor Costs Consensus Forecast for revised Q4 06: 3.0 percent rate
Range: 1.9 to 6.2 percent rate

Factory orders posted a 2.4 percent gain in December, largely on a spike in aircraft orders. However, the advance report for durables orders in January showed a drop in aircraft orders - which generally are volatile - but also included widespread weakness in other components. Durables orders in the advance report dropped 7.8 percent in January and even with revisions, we can expect durables to pull overall factory orders down sharply.

Factory orders Consensus Forecast for January 07: -4.5 percent
Range: -5.1 to -3.5 percent

Wednesday
Consumer credit slowed in December to a $6.0 billion increase, following a sharp $13.7 billion surge in November. Most of the slowing was in revolving credit. With consumer spending up in January, it will be telling to see whether a rising share was funded out of credit or from income growth. Moderate credit growth in January would indicate that the consumer has more staying power with spending coming out of income growth rather than cutting into available credit.

Consumer credit Consensus Forecast for January 07: +$5.0 billion
Range: +$2.0 billion to +$10.5 billion

Thursday
Initial jobless claims rose 7,000 in the week ended February 24 week to 338,000. The four-week average also rose, up 7,500 to 335,250 and its highest level since October 2005. Recent jobless claims have been volatile but have been trending up somewhat, suggesting a moderation in employment growth.

Jobless Claims Consensus Forecast for 2/27/07: 335,000
Range: 320,000 to 340,000

Friday
Nonfarm payroll employment growth slowed to a 111,000 gain in January. January's increase was notably slower than in recent months as December payrolls advanced by 206,000 and November by 196,000. Gains need to average in the 100,000 to 120,000 vicinity to help ease the unemployment rate. The civilian unemployment rate remains low at 4.6 percent in January. The January employment report had good news on the inflation front as average hourly earnings decelerated to a 0.2 percent increase in January, following a 0.4 percent boost in December. Given last week's nervousness over the strength of the economy, a moderately healthy gain in payroll jobs combined with a modest increase in wages is what the markets would likely see as remaining on the proverbial soft landing.

Nonfarm payrolls Consensus Forecast for February 07: 95,000
Range: 40,000 to 150,000

Unemployment rate Consensus Forecast for February 07: 4.6 percent
Range: 4.5 to 4.7 percent

Average workweek Consensus Forecast for February 07: 33.8 hours
Range: 33.7 to 33.9 hours

Average hourly earnings Consensus Forecast for February 07: +0.3 percent
Range: +0.1 to +0.4 percent

The U.S. international trade gap widened to $61.2 billion in December from $58.1 billion deficit in November. The increase in the trade deficit was primarily due to a jump in imports - primarily oil and with the continued upward creep in oil prices, we are likely to see a repeat in January. Markets should also be watching the export number to see if foreign support of U.S. manufacturing is holding up. Exports rose 0.6 percent in December, following a 1.1 percent jump in November.

International trade balance Consensus Forecast for January 07: -$59.8 billion
Range: -$61.0 billion to -$58.6 billion

Special reminder - Daylight Saving Time begins this coming Sunday in the U.S. - two weeks earlier than usual. Most of the United States begins Daylight Saving Time at 2:00 a.m. on Sunday, March 11. In Europe and the UK, Summer Time begins on Sunday, March 25. Australia returns to standard time on March 25. Japan does not observe Daylight Saving Time.