Recap of US Markets

OIL PRICES

Oil prices continued upward last week – primarily due to tensions over the Iranian seizure of United Kingdom marines and sailors. Additionally, both crude and distillate stocks were down. Forecasters continue to see a healthy driving season keeping oil and gasoline up. Net for the week, spot prices for West Texas Intermediate jumped $4.96 per barrel to close at $65.87 per barrel. Spot spices are up $15.57 per barrel since mid-January – clearly putting upward pressure on core inflation through cost effects.

STOCKS

Equities declined last week over concern over weak economic growth, less dovish comments from Fed Chairman Ben Bernanke, and high inflation numbers. While economic data last weak was mixed, equities seemed to focus more on problems in housing and the soft durables orders excluding aircraft. The biggest losses last week were Tuesday and Wednesday. Tuesday saw equities rattled by a weak profit report by the nation’s largest homebuilder, Lennar. A drop in new home sales reported on Monday helped to set up the reaction. On Wednesday, durables order came in weak outside of aircraft but the big factor pushing down equities were comments by Fed Chairman Ben Bernanke. He explicitly stated that the Fed retained its anti-inflation bias at the latest FOMC meeting, indicating that interest rates are not likely to decline soon. Thursday got a little lift from an upward revision to fourth quarter GDP – indicating that the economy might not be too soft after all. Offsetting was a jump in oil prices. Higher oil price, in fact, weighed on equities all week. Indexes were generally mixed on Friday despite strong income numbers reported in the morning. On Friday the Commerce Department announced sanctions against China for subsidizing certain industries and several key stocks in the U.S. were negatively affected –notably Boeing and GE, pulling the S&P500 down.

Last week, the Dow was down 1.0 percent; the S&P 500, down 1.1 percent; the Nasdaq, down 1.4 percent; and the Russell 2000, down, 1.1 percent.

Despite a down final week, March actually rebounded notably after the drop in February. For the month, the Dow is up 0.7 percent; the S&P500, up 1.0 percent; the Nasdaq, up 0.2 percent; and the Russell 2000 is up 1.0 percent.

Over the first quarter, equities clearly picked up in volatility – especially the small caps. Indexes generally rose from the end of 2006 into the latter part of February. All major indexes fell sharply in the latter part of February, rebounded during most of March, and then fell on Bernanke’s comments last week. Blue Chips remain at or below the year-end close while small caps are slightly positive since year-end.

Year-to-date, the Dow is down 0.9 percent; the S&P500, up 0.2 percent; the Nasdaq, up 0.3 percent; and the Russell 2000 is up 1.7 percent.

BONDS

Interest rates were mixed last week with short rates edging down and long rates firming. Flight to safety helped nudge short term rates down over concerns that the Iranian seizure of United Kingdom sailors and marines could worsen. However, inflation fears – notably with Fed Chairman Bernanke’s comments on Wednesday and with a rise in the core PCE price index reported last Friday – bumped up longer rates.

Net for the week the Treasury yield curve was mixed. Yields were up as follows: 5-year, up 3 basis points; the 10-year bond, up 4 basis points; and the 30-year bond, up 4 basis points. The 3-month T-bill was down 2 basis points as was the 2-year note. The 3-year note was unchanged net.

Over the last four weeks, the longer maturities have been trending up, reflecting the view that the economy is not quite as weak as earlier believed. Additionally, some in the bond markets are starting to have doubts about the Fed’s resolve to fight inflation.

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

Last week we got a very healthy report on the consumer sector but bad news on inflation. Manufacturing remains soft as does housing. Nonresidential construction has resumed its uptrend.

Personal income remains strong as does inflation

Last Friday saw confirmation that the consumer sector still has plenty of oomph to support the economy, further alleviating fears of recession. Personal income rose a robust 0.6 percent in February, following a 1.0 percent spike in January. The wages & salaries component advanced 0.4 percent, following a 1.2 percent surge in January. January’s jump was largely due to January increases in government worker salaries and due to private sector bonuses.

Personal income on a year-on-year basis edged up to up 5.3 percent from up 5.2 percent in January. On the same basis, the wages and salaries component fell to up 4.4 percent year-on-year in February from up 5.0 percent in January.

Spending was strong but quite mixed. Personal consumption expenditures increased 0.6 percent, following a 0.5 percent gain in January. Curiously, all on the spending increase was in services. Durables and nondurables were flat in February, but durables followed a very strong January. However, gasoline sales were up in February, yet nondurables spending was flat. The January/February average for consumer spending is healthy but it will take at least another month to see the direction of spending on the margin.

The disconcerting news is on inflation. Energy costs bumped up the overall PCE deflator to a 0.4 percent boost in February, following a 0.2 percent increase the month before. The core PCE price index (excluding food and energy) firmed further to 0.3 percent, following a 0.2 percent increase in January.

The latest news on the PCE price index confirms the Fed’s concern that inflation is not coming down consistently yet. On a year-on-year basis, the overall PCE deflator is up 2.3 percent in February, compared to up 1.9 percent in January. On a year-on-year basis, the core deflator edged back up to up 2.4 percent from up 2.2 percent in January. The latest numbers are well above the Fed’s implicit target zone of 1 to 2 percent annualized inflation.

Durables orders soft outside of aircraft

Manufacturing is now the second area of concern for weakness in the economy – with housing being the first. Industrial production has been down in four of the last six months. Durable goods orders rebounded in February but strength was primarily in aircraft orders.  Durable goods orders rebounded 2.5 percent in February, following a sharp 9.3 percent drop in January. Excluding the volatile transportation component, new orders edged down 0.1 percent, following a 4.0 percent fall in January. Outside of aircraft, weakness was broad-based.

Strength in orders in February was in transportation, up 9.6 percent, and in computers & electronics, up 6.4 percent. Weakness was broad-based.  Industry categories showing declines in February were primary metals, down 1.0 percent; fabricated metal products, down 2.3 percent; machinery, down 0.4 percent; electrical equipment, down 5.5 percent; and “other,” down 1.3 percent.

Year-on-year, new orders for durable goods declined to up 0.1 percent in February from up 4.6 percent in January. Unfilled durables orders stood at up 20.7 percent year-on-year in February compared to up 21.1 percent in January. Unfilled orders are still buffering some of the impact of soft new orders.

Chicago NAPM gives hope for manufacturing improvement

Giving some hope of improvement in manufacturing was a spike in the Chicago purchasers' index which jumped to 61.7 in March from 47.9 in February. New orders and backlogs posted similar gains. However, this survey, which also includes non-manufacturers, is known to be quite volatile due to a relatively small sample size.

New home sales continue downward

Housing remains an area of concern for the economy. New home sales fell sharply in February, down 3.9 percent to a lower-than-expected annual rate of 848,000 units -- the lowest rate in nearly seven years.  Unfortunately, there was a jump in supply to 8.1 months -- up from 7.3 months in January and 6.1 months in December and the highest level in 16 years.

Construction outlays boost confidence outside of housing

While housing is still very weak, other facets of the construction industry are still quite healthy. Construction rebounded in February as outlays rose 0.3 percent in February, following a 0.5 percent drop in January. The gain was led by nonresidential and public construction outlays. Residential construction continued to decline. On a year-on-year basis, overall construction outlays edged down to down 2.4 percent in February from down 2.3 percent in January.

In the latest month, private residential construction fell 1.0 percent in February, following a 1.7 percent drop in January. Private nonresidential jumped 2.3 percent in February, following dip of 0.3 percent in January. Private nonresidential outlays are up 15.9 percent in February on a year-on-year basis, compared to up 13.2 percent in January. Public construction was another source of strength in February with a 0.4 percent gain after rising 1.6 percent the prior month. Public construction is up 10.4 percent year-on-year in February, compared to up 11.7 percent in January.

The bottom line is that the construction sector is not falling off a cliff – thanks to nonresidential and public sector activity.

GDP revised up for Q4 but inflation steady

The economy remains far from recession. Fourth quarter real GDP was revised up to an annualized 2.5 percent from the prior estimate of 2.2 percent. The fourth quarter pace followed a 2.0 percent annualized increase in the third quarter. We still have had three quarters of economic growth below potential growth of 3 percent. A moderate gap between actual and potential GDP is needed to help ease inflation.

On the inflation front, the fourth quarter GDP price index was unrevised from the previous estimate of 1.7 percent. The consensus had projected no net revision from the February release estimate of 1.7 percent for the fourth quarter. The core PCE deflator also was unrevised from the previous estimate of 1.9 percent.

However, the GDP price data are lagging the PCE price index data. The markets’ and the Fed’s focus clearly is on the more current and high core PCE price index.

The bottom line

The economy is moving along in a very choppy fashion. Growth is at an inflection point and it is normal during this phase of the business cycle that some sectors are weak and others are moderately healthy and such is currently the case. Housing is down while nonresidential construction is strong. Manufacturing is sluggish but the consumer is still robust. Unfortunately, inflation also seems to be too robust. The Fed will likely remain in a holding pattern and the economy will stay choppy – but without recession.

Looking Ahead: Week of April 2 through April 6

Looking ahead, we get new data on motor vehicle sales and manufacturing and end the week with the March jobs report on Friday morning.

Monday

The Institute for Supply Management’s manufacturing index rose to 52.3 in February from 49.3 in January. The ISM index is likely to get more attention than usual by the markets due to concern over whether manufacturing is more than slowing and going into recession. Manufacturing data have been mixed with the Chicago Purchasing Managers index jumping in March and the Census Bureau’s new durables orders being down outside of transportation. 

ISM manufacturing index Consensus Forecast for March 07: 51.5
Range: 50.0 to 53.5

Motor vehicle sales came in at a 12.6 million annual rate for February – with a 4.9 million rate for cars and a 7.7 million rate for light trucks. Recent strength in personal income could translate into higher sales – although the rebound in gasoline prices will likely cut into light trucks' share.

Motor vehicle sales Consensus Forecast for March 07: 12.7 million-unit rate
Range: 12.6 to 12.9 million-unit rate

Wednesday

Factory orders fell a sharp 5.6 percent in January, pulled down largely by lower Boeing orders. More recently, durables orders rebounded in February by 2.5 percent, following a sharp 9.3 percent drop in January. Again, Boeing orders were responsible for the swing. The nondurables portion of total orders is likely to be up due in part to higher oil prices.

Factory orders Consensus Forecast for February 07: +1.7 percent
Range: +1.5 to +2.7 percent

The business activity index from the ISM non-manufacturing survey fell sharply to 54.3 in February, from 59.0 in January. However, this index has not been below the breakeven point of 50 since March 2003, then with a level of 46.3.

Business activity index Consensus Forecast for March 07: 55.0
Range: 52.5 to 57.1

Thursday

Initial jobless claims fell 10,000 to 308,000 for the week ending March 24. The drop pushed down the four-week average by 7,250 to 316,750. The labor market continues to remain tighter than many expected and is helping to support the consumer sector. The negative is that the Fed remains concerned about wage inflation.

Jobless Claims Consensus Forecast for 4/1/07: 317,000
Range: 310,000 to 325,000

Friday

Nonfarm payroll employment slowed to a 97,000 rise in February, following a 146,000 boost in January and a 226,000 advance in December.  With recent improvement in jobless claims, payroll increases may improve. However, given the weakness in manufacturing and in housing, expect the improvement to be in services. Wages were strong in February with a 0.4 percent gain, following a 0.2 percent rise in January. Markets will be watching to see if the average hourly earnings figure moderates to help sooth the Fed’s inflation concerns.

Nonfarm payrolls Consensus Forecast for March 07: 135,000
Range: 70,000 to 216,000

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

Average workweek Consensus Forecast for March 07: 33.8 hours
Range: 33.8 to 33.8 hours

Average hourly earnings Consensus Forecast for March 07: +0.3 percent
Range: +0.2 to +0.4 percent

Consumer credit rose $6.5 billion in January, up from a $5 billion increase in December. January's increase was concentrated in nonrevolving credit.

Consumer credit Consensus Forecast for March 07: +$5.0 billion
Range: -$5.0 billion to +$8.5 billion