Despite the negative fundamentals, consumers decided to open their wallets and purses and went on a moderate spending spree in November.  Also, consumer spirits were less gloomy in early December, according to the latest sentiment report.  Combined with a jump in exports in October, the recovery is gaining more traction.

Recap of US Markets

STOCKS

A variety of factors impacted equities this past week.  Despite net good news on the economy, equities ended the week mixed with Blue Chips showing gains; techs and small caps down. 

After a positive open on the first day of the week, comments by Fed Chairman Ben Bernanke that the economy still faces “headwinds” led equities to end the day slightly mixed.  Tuesday showed a widespread retreat in stock prices on a downgrade to Greece’s debt rating, news of disappointing profits from Kroger and McDonald’s, and a rise in the dollar (heavily against the euro) undermining energy and commodities companies.  Also, news of a $3.65 billion loss by a Dubai developer weighed on financials.

Midweek saw a rebound in equities on a decline in the dollar, an upgrade to 3M, and a boost in wholesale inventories.  The rise in inventories was seen as a vote of confidence by businesses that the economy is improving.  Most indexes posted gains on Thursday despite an unexpected rise in initial jobless claims.  Traders chose instead to focus on a dip in continuing jobless claims and another gain in the export component of the international trade report.  The week ended on a positive note as unexpectedly strong retail sales for November and a rise in consumer sentiment bolstered equities.

Equities were mixed this past week. The Dow was up 0.8 percent; the S&P 500, fractionally above no change; the Nasdaq, down 0.2 percent; and the Russell 2000, down 0.4 percent.

For the year-to-date, major indexes are up as follows: the Dow, up 19.3 percent; the S&P 500, up 22.5 percent; the Nasdaq, up 38.9 percent; and the Russell 2000, up 20.2 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 were mixed this past week with mid- and long maturity rates up on stronger economic data.  But yields headed down the first two days of the week.  First, Fed Chairman Ben Bernanke’s comments about “headwinds” on economic growth and that inflation could come down bumped rates down.  Concern about the impact on financial institutions worldwide from the downgrade on Greek debt led to flight to safety, also weighing on rates.  Moody’s downgrade of Illinois' general obligation bond rating further added to flight to safety.

Rates bumped up significantly on the last two days of the week.  A poorly received long bond auction was part of the reason.  But strong economic data were the primary factors behind the boost in yields.  These included Thursday’s sharp narrowing in the U.S. trade deficit and Friday’s gains in retail sales and consumer sentiment.

For this past week Treasury rates were mixed as follows: 3-month T-bill, down 2 basis points; the 2-year note, down 3 basis points; the 5-year note, up 1 basis point; the 7-year note, up 5 basis points; the 10-year bond, up 8 basis points; and the 30-year bond, up 10 basis points.

OIL PRICES

This past week, spot prices for West Texas Intermediate settled below $70 per barrel for the first time in over two months.  Several factors weighed on spot WTI.  First, the U.S. Energy Information Administration lowered its short-term outlook for demand in 2010 and boosted its forecast for OPEC and non-OPEC production.  At mid-week, the Energy Department showed that crude oil inventories declined in the latest week.  But the bulk of the drop occurred in states along the Gulf of Mexico.  In contrast, crude inventories at Cushing, Oklahoma, where New York-traded West Texas Intermediate oil is stored, spiked 8 percent, weighing on spot prices for WTI.  Also, gasoline and distillates inventories gained, indicating less need for crude in the near term.

Finally, the dollar was up significantly.  For the week, the Dollar Index was up 0.9 percent, weighing heavily on crude prices.

Net for the week, spot prices for West Texas Intermediate fell $5.17 per barrel to settle at $69.86 – and coming in $11.78 below the recent high of $81.64 this October 21 and $75.43 below the record settle of $145.29 per barrel set on July 3, 2008.

The Economy

The economic news was mostly good this past week with gains in retail sales, consumer sentiment, and exports.  As noted above and in Looking Ahead, initial jobless claims unexpectedly rose in the latest week, but financial markets generally chose to ignore that news.  Overall, the recovery is gaining somewhat better footing.  However, it is too early to argue that the recovery is going to be better than sluggish.

Retail sales unexpectedly bright in November

For now, retailers are not worrying about the why or how—but store managers are certainly happy that sales were unexpectedly strong for November. Sales were up significantly—and beyond just autos and gasoline. Overall retail sales in November posted a 1.3 percent spike after a 1.1 percent gain in October.  Excluding autos, sales gained 1.2 percent in the latest month after no change in October.  Even excluding both autos and gasoline, November sales were up a healthy 0.6 percent, following a 0.1 percent uptick the month before.

The November increase in overall sales was led by a 6.0 percent jump in gasoline sales with notable strength also seen in electronics & appliance stores, up 2.8 percent, and in auto dealers, up 2.0 percent.  Also rising were building materials & garden equipment, food & beverage stores, health & personal care, sporting goods & hobby stores, general merchandise, nonstore retailers, and food services & drinking places.

Going forward, the big question is whether the consumer can keep spending growth healthy.  A reasonable, strong pace “may” continue based on the fact that consumers cut spending back so sharply during the recession.  Pent up demand may provide momentum in the near-term as consumers try to make up for some of the purchases put off during the recession.  On a year-ago basis, sales were far worse during the latest recession than for the 2001 recession.   For retail sales excluding autos and gasoline, the bottom year-ago number in 2001 was 0.8 percent for September of that year.  For the recent recession, the comparable number was minus 4.5 percent for July 2009 (which actually may be one month into recovery).  In terms of pent up demand, there is more upside potential this recovery.  But this recovery also has higher unemployment and other greater negatives in the labor sector.

For the latest report, overall retail sales on a year-ago basis improved to up 1.9 percent, from down 2.0 percent in October. Excluding motor vehicles, the year-on-year rate increased to up 1.3 percent in November from down 2.8 percent the previous month. 

While there is still a big question over how well the consumer is going to keep spending, for now the news is good.  The strong November sales numbers will add to estimates for fourth quarter GDP growth.

Consumer sentiment picks up – a little

Consumer spirits are picking up just in time for the final push on Christmas sales. The Reuters/University of Michigan consumer sentiment index for mid-month December jumped to 73.4 from 67.4 for the November final estimate.  The latest gain was led by a spurt in the current economic conditions index—to 79.1 from 68.8 in November.  The expectations index improved, but only slightly—to 69.7 from 66.5 the prior month.

While the gain in the overall index is good news, the level is still rather low.  November’s figure is well below pre-recession peaks of 103.8 in January 2004 and 96.9 in January 2007.

The good news for the Fed is that inflation expectations are falling. Inflation expectations for one year out dipped 6 tenths to 2.1 percent and for five years out declined 4 tenths to 2.6 percent. The easing likely reflects generally lower prices for gasoline and consumer expectations for soft economic activity.  Some Fed officials have stated that any boost in inflation expectations could speed up when the Fed tightens monetary policy.

Exports up as trade deficit shrinks in October

The brightest spot in the economy likely is exports. The latest international trade report shows exports continuing an uptrend. A lower dollar clearly is making a difference, boosting U.S. exports and manufacturing. The overall U.S. trade deficit narrowed to $32.9 billion from a revised $35.7 billion gap in September. Exports advanced 2.6 percent while imports gained 0.4 percent.  Exports have risen for six consecutive months.

In the latest month, exports were led by a $1.2 billion jump in capital goods ex autos in October, followed by gains in consumer goods and autos.

Imports also gained, likely reflecting inventory rebuilding for autos and cautious hope about the consumer and business investment.  Apparently, U.S. businesses are a little optimistic about domestic demand for both capital equipment and consumer goods. Import gains were led by a $1.1 billion boost in capital goods ex autos, followed by a $1.0 billion rise in consumer goods imports and $0.4 billion for autos. Industrial supplies imported fell $1.8 billion, with the crude oil component falling even more-by $2.4 billion. However, some of the auto imports may be lagged effects from the surge in auto sales under the cash-for-clunkers program as import auto dealers restocked.

Year-on-year, overall exports in October improved to minus 8.6 percent from minus 12.2 percent the month before while imports increased to down 18.8 percent from minus 20.3 percent in September.

Import prices surge in November

The dollar's steep drop in recent months is showing up in higher prices for imports as seen in a surge in November import prices. Fortunately, the jump was primarily in commodities as import price inflation for finished goods is still soft. Overall import prices jumped 1.7 percent in November, following a 0.8 percent gain in October.  

By end-use categories, November's increase was led by a 4.8 percent boost for industrial supplies which included a 6.2 percent gain for petroleum & petroleum products.  Foods, feeds & beverages rose 0.5 percent in the latest month.

What is not yet increasing are prices for imported finished goods. For November, capital goods import prices were up 0.2 percent while autos rose a modest 0.1 percent. Prices for imported consumer goods excluding autos actually declined 0.1 percent.

But on a year-ago basis, import prices are not nearly as weak as they had been.  Overall import prices were up 3.7 percent in November versus down 5.6 percent year-ago for October.  Excluding petroleum imports, November year-ago was minus 1.6, compared to minus 4.0 percent for October.  Despite the weaker dollar, outside of commodities, import price inflation generally is still tame.  And recent gains in the dollar will help keep it that way—at least for the near term.

The bottom line

This past week, we got pleasant upside surprises with the retail sales and international trade reports.  While the recent gains in exports are in line with the fundaments for the trade sector (still low dollar and moderately healthy growth abroad), the recent surge in retail sales may not be.  Consumers in October and November picked up the spending pace—the question is whether it can continue.  Pent up demand may be providing the boost.  Longer-term gains for consumer spending are going to require real improvement in the fundamentals—namely, lower unemployment, job growth, and income growth.

Looking Ahead: Week of December 14-18 

This coming week is jam packed with market moving indicators.  For those who have not closed the books for the year, there is a lot that can affect year-end balance sheets.  On the inflation front, we get new numbers for the PPI and CPI.  The cyclically sensitive goods-producing sector gets updates on housing starts and industrial production.  At mid-week, the Fed announces its final policy decision for the year.  Finally, Friday’s quadruple witching could create some volatility even before Friday.

Tuesday

The producer price index increased 0.3 percent in October after dropping 0.6 percent the month before. The rise in the latest month was led a 1.6 percent boost in energy and a 1.6 percent gain also for food.  But at the core level, the PPI rate unexpectedly dropped 0.6 percent, following a 0.1 percent dip in September.  The fall at the core level was due mainly to declines in prices for light trucks and passenger cars.  Looking ahead, there is still upward pressure on the headline figure from higher oil prices.  Imported petroleum prices were up 6.2 percent in November.  Also, seasonally adjusted spot prices for West Texas Intermediate increased 6.9 percent for the month.

PPI Consensus Forecast for November 09: +1.0 percent

Range: +0.5 to +1.2 percent

PPI ex food & energy Consensus Forecast for November 09: +0.2 percent

Range: 0.0 to +0.4 percent

The Empire State manufacturing index fell back more than 11 points to 23.51 in November. The new orders component also showed an easing in the pace of growth, declining to 16.66 in November from October's 34.57. Based on the new orders index, the general business conditions index could soften in December though likely remain in positive territory.

Empire State Manufacturing Survey Consensus Forecast for December 09: 25.0

Range: 15.6 to 27.0

Industrial production in October edged up only 0.1 percent, following a 0.6 percent boost the prior month. However, the manufacturing component declined 0.1 percent, following a 0.8 percent jump in September.  Overall capacity utilization in October continued its rise from the historical low set in June, posting a gain to 70.7 percent from 70.5 percent in September.  Looking ahead, earlier-released manufacturing indicators mostly suggest improvement in industrial production for November.  From the employment situation, production worker hours in manufacturing were up 0.4 percent for the month.  Key manufacturing surveys were in positive territory for November—including ISM, Philly Fed, and Empire State. 

Industrial production Consensus Forecast for November 09: +0.6 percent

Range: +0.2 to +0.9 percent

Capacity utilization Consensus Forecast for November 09: 71.2 percent

Range: 70.8 to 72.0 percent

Wednesday

The consumer price index in October firmed to a 0.3 percent boost after rising 0.2 percent the month before. Core CPI inflation was unchanged with a 0.2 percent increase.  Boosting the headline number was a 1.5 percent jump in energy prices. Food price inflation was restrained in October with a 0.1 percent rise.  Looking ahead, there is still upward pressure on the headline figure from higher oil prices.  Imported petroleum prices were up 6.2 percent in November.  Also, seasonally adjusted spot prices for West Texas Intermediate increased 6.9 percent for the month.

CPI Consensus Forecast for November 09: +0.4 percent

Range: +0.2 to +0.6 percent

CPI ex food & energy Consensus Forecast for November 09: +0.1 percent

Range: +0.1 to +0.2 percent

Housing starts in October unexpectedly dropped 10.6 percent, following a 1.9 percent gain the month before. The fall in October was led by a 34.6 percent plunge in multifamily starts but the single-family component also slipped—by 6.8 percent.

Housing starts Consensus Forecast for November 09: 0.575 million-unit rate

Range: 0.540 million to 0.600 million-unit rate

The FOMC announcement for the December 15-16 FOMC policy meeting is expected to leave the fed funds target rate unchanged at a range of zero to 0.25 percent.  However, traders will be watching to see if the “extended period” language is qualified with any additional wording regarding the future path of the fed funds rate.  Traders also will look for updates on the Fed’s view of the recovery and on the Fed’s plan for unwinding balance sheet expansion.

FOMC Consensus Forecast for 12/16/09 policy vote on fed funds target range: unchanged at a range of zero to 0.25 percent

Thursday

Initial jobless claims for the December 5 week ended five weeks of improvement, rising 17,000 to 474,000 for the highest level since mid-November. But the four-week average improved, dropping 7,750 to 473,750. Continuing claims in data for the November 28 week fell very sharply, down 303,000 to 5.157 million. The drop in continuing claims reflects an uncertain mix of new hiring and the expiration of benefits.

Jobless Claims Consensus Forecast for 12/12/09: 465,000

Range: 460,000 to 470,000

The Conference Board's index of leading indicators rose 0.3 percent in October. The big positive once again was the rate spread, standing at 32 basis points between the fed funds rate and 10-year Treasury yield. Without the sizeable contribution from the rate spread, the leading index would have been flat for October.

Leading indicators Consensus Forecast for November 09: +0.7 percent

Range: +0.6 to +0.9 percent

The general business conditions component of the Philadelphia Fed's business outlook survey index for November rose to 16.7 in November from 11.5 in October. Employment was a big plus, only marginally negative at minus 0.5 in a big improvement and the latest hint that layoffs are winding down. Looking ahead, we may see improvement in the general business conditions index as the new orders index in November rose sharply, to 14.8 from 6.2 the month before.

Philadelphia Fed survey Consensus Forecast for December 09: 16.5

Range: 6.9 to 18.0

Friday

Quadruple Witching

R. Mark Rogers is the author of The Complete Idiot’s Guide to Economic Indicators, Penguin Books, October 2009.

Econoday Senior Writer Mark Pender contributed to this article.