Recap of US Markets

The best of all worlds: Healthy growth with no inflation
The capture of Saddam Hussein had virtually no standing impact on financial markets this past week. The bond market focused on the November dip in the CPI which showed that inflationary pressures would not soon be upon us. Bond investors can indeed believe the Fed and its promise to keep interest rates on hold for a while. Since inflation is not likely to be a concern soon, bond investors virtually ignored strong economic news this week, including a boom in housing starts and a strengthening in the industrial sector.

Equity markets rallied on strong economic data for a change, gaining especially on Tuesday (housing, production with no inflation) and Thursday (Philadelphia Fed Survey). Not surprisingly, the Saddam capture-effect was short-lived with a mini-rally on Monday morning that eroded quickly over the course of the day. After all, Hussein's capture is not likely to end the skirmishes in Iraq.

Equity market gains were not equal this week as the Dow increased but the NASDAQ composite index was virtually unchanged. While high tech industries are clearly showing healthy production gains, many investors feel that the year-to-date gain in the NASDAQ composite (roughly 46 percent) is already high. Perhaps it is, but remember that this composite index fell a whopping 78 percent from peak (March 2000) to trough (October 2002). The index remains more than 60 percent below the March 2000 peak.

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

Housing starts reach 19-year high
Housing starts jumped 4.5 percent in November to a 2.07 million-unit rate after posting a 2.5 percent gain in October. Total starts are now 17.6 percent higher than a year ago - and reached their highest level since February 1984. It doesn't hurt that mortgage rates have remained below 6.5 percent for 17 consecutive months. This is a record since the series began in 1971. In the past couple of years, housing starts have been bolstered by low mortgage rates as well as demographic trends. In the most recent six months, rates have remained low, and economic activity (income growth) has begun to improve. This has boosted housing construction to levels we haven't seen in 20 years. Keep in mind, however, that housing starts can get additional boosts from seasonal adjustment factors during winter months when weather conditions are milder than usual.

There is no question that the home furnishings industry is benefiting from a healthy housing market. Sales at furniture and home furnishing stores are posting healthy monthly gains and are sharply above year-ago levels. Similarly, sales at electronic and appliance store sales have also risen sharply this year. Granted, electronic store sales are also benefiting from sales on plasma and flat panel televisions. Nevertheless, new houses require new appliances.

One wonders how long the housing market boom can continue. However, low interest rates coupled with an expanding economy could help keep construction sites bustling for some time. Consumers will also be more willing to remodel and build additions when the labor market situation is more stable.

Manufacturing activity is lively
Two Fed surveys revealed that manufacturing activity continued to grow at a lively pace in December. The Empire State Manufacturing index, which covers the New York region, edged back to 37.4 in December after surging to 40.1 in November. There is no question that this reflects healthy activity in the region. The Philadelphia Fed Survey jumped more than 6 percentage points to reach 32.1 in December. Undoubtedly, the pace of activity accelerated in the fourth quarter in this Fed region. While the Empire State index is relatively new, the Philadelphia Fed Survey has a long history and it has proven to be a good leading indicator of industrial production. These figures suggest that industrial production should post another strong hike in December.

Indeed, the index of industrial production increased 0.9 percent in November, the largest monthly gains since October 1999! While production of consumer goods rose a solid 0.4 percent, business equipment jumped 1.7 percent. Production of non-industrial supplies increased 0.9 percent and materials gained 1.1 percent. High tech industries continued to play a major role in production gains in November, in contrast to motor vehicles where assemblies edged down slightly for the month.

After a brief dip in the spring and summer, industrial production is once again posting year-over-year gains. The capacity utilization rate appears to have bottomed out in June at 74 percent. By November, the operating rate was 1.7 percentage points higher at 75.7 percent. Nevertheless, this is low by historical standards and reveals that the economy still has a lot of slack. It is a major reason behind the Fed's belief that inflationary pressures are not likely to start percolating any time soon and that a low interest rate environment is still the best policy.

CPI posts rare monthly drop
The consumer price index fell 0.2 percent in November after remaining unchanged in October. Energy prices dropped 3 percent in November, after a 3.9 percent decline in October and are now down 14.9 percent from a year ago. Food prices edged up 0.4 percent during the month. Excluding the volatile food and energy components, the CPI edged down 0.1 percent. Several components posted declines during the month including apparel, transportation, housing and other goods and services. As a result, the total CPI as well as the core components have moderated their year-over-year gains over the past few months.

The low rate of consumer price inflation gives Federal Reserve officials leeway in determining monetary policy. Given that inflationary pressures are not an issue these days, the Fed can maintain an accommodative policy without fear that inflation will rear its ugly head in the near term. The low rate environment will encourage economic and employment growth, helping the jobless rate to decrease in the coming year.

The Bottom Line
This week's set of news is the same as the prior week -- economic indicators are consistently and decidedly upbeat. The housing market remains the economy's soaring star, but now manufacturing and industrial production have regained their footing. Production of business equipment was a laggard in this recovery, but is now building some steam. While foreign economies continue to grow at a slower pace than the U.S., a depreciation in the foreign exchange value of the dollar may help boost exports and industrial production in 2004.

Looking Ahead: Week of December 22 to December 26

Tuesday
The Commerce Department's second revision for real GDP growth typically doesn't show much change from the first revision. Despite comprehensive benchmark revisions that were reported on December 10, the current year's GDP growth pattern was not significantly altered. Most economists expect that the final third quarter pace will not differ very much from the torrid pace reported last month of 8.2 percent. Real final sales are also expected to remain near their last estimate which showed an 8 percent rate of growth, and the GDP deflator should not differ from the previously reported 1.7 percent rate.

Real GDP Consensus Forecast for Q3-03: 8.2 percent
Range: 8.2 to 8.3 percent

GDP deflator Consensus Forecast for Q3-03: 1.7 percent
Range: 1.7 to 1.7 percent

Personal income rose 0.4 percent in October after a 0.3 percent hike in September. Despite some improvement in the labor market, economists are still expecting only moderate gains in November. While employment is slowing expanding, average hourly earnings gains are still meager these days.

Personal consumption expenditures were unchanged in October, primarily due to a drop in motor vehicle sales. Retail sales were somewhat better in November as increases were registered in several categories. Motor vehicle sales posted gains during the month, which should boost total consumption.

Personal income Consensus Forecast for Nov 03: 0.4 percent
Range: 0.3 to 0.5 percent

Personal consumption expenditures Consensus Forecast for Nov 03: 0.7 percent
Range: 0.4 to 0.9 percent

The University of Michigan's consumer sentiment index declined almost 4 percentage points in early December to a level of 89.6, surprising economists and market participants who had been anticipating better sentiment figures. Usually, final figures at the end of the month are not very different from the mid- month reading, but economic data have generally been strengthening over time and this could bode well for the final reading of the year.

Consumer sentiment Consensus Forecast for Dec 03: 91
Range: 89.5 to 92

Wednesday
New jobless claims declined 22,000 in the week ended December 13 to a level of 353,000 after posting gains in the two previous weeks. In any case, claims have remained solidly below the 400,000 mark for 11 weeks now. Keep in mind that holidays distort weekly claims figures, and this season holds many holidays.

Jobless Claims Consensus Forecast for 12/20/03: 350,000 (-3,000)
Range: 345,000 to 360,000

Durable goods orders jumped 3.4 percent in October after rising 2.2 percent in September. Gains were registered across the board, with particularly robust increases for primary metals (6.1 percent) and transportation (5.5 percent). Continued strength in durable goods orders indicates further strong increases in industrial production down the road.

Durable goods orders Consensus Forecast for Nov 03: 1.0 percent
Range: -1.0 to 2.0 percent

New home sales decreased 3.5 percent in October to a 1,105,000-unit rate. This was the second monthly decline which put new home sales roughly 100,000 below their June peak. Housing starts surged in November, however, and this could point to a revival in new home sales. Often, single-family housing starts are a leading indicator for new single-family home sales.

New home sales Consensus Forecast for Nov 03: 1,125,000
Range: 1,080,000 to 1,200,000

Looking Ahead: Week of December 29 to January 2

Monday
Existing single-family home sales dropped 4.9 percent in October to a 6.350 million-unit rate. Despite the decline, the level of existing home sales over the past three months remains at record levels. Often existing home sales will move in the same direction as single family housing starts, and these rose in November.

Existing single-family home sales Consensus Forecast for Nov 03: 6.48 million unit rate
Range: 6.10 to 6.55 million unit rate

Tuesday
The NAPM-Chicago, which measures manufacturing and non-manufacturing activity in the Chicago region, jumped to 64.1 in November, its highest level since 1995. While this index measures non-manufacturing activity and thus should be viewed with caution, it is regarded as a leading indicator of the ISM manufacturing index. Should the index remain near its current high level, it bodes well for economic activity in general, not just the manufacturing sector.

NAPM-Chicago Consensus Forecast for Dec 03: 60.1
Range: 58 to 64.5

The Conference Board's consumer confidence index jumped 10 percentage points in November to reach 91.7. This index is heavily weighted towards consumer assessment of labor market conditions. The recent gains in nonfarm payrolls, however modest they are, have given consumers reason to expect improvement in the economy.

Consumer confidence Consensus Forecast for Dec 03: 92
Range: 89 to 97

Wednesday
New jobless claims have shown solid improvement over the past three months and this bodes well for employment growth. Historically, when jobless claims run around 350,000 per week, nonfarm payrolls increase about 150,000 per month. Certainly, larger employment gains are desirable, but this would get the labor market recovery off the ground.

Jobless Claims Consensus Forecast for 12/27/03: NA
Range:

Friday
The ISM manufacturing index jumped nearly 6 percentage points in November to reach a high of 62.8 - a level not seen in nearly 20 years. More important than the overall level of the index were healthy gains in new orders, production and supplier deliveries. Even inventories and employment reached the 50 percent mark, which signifies expansion!