Last week the markets expected weak housing sales but the numbers came in even lower than expected. However, manufacturing came in reasonably healthy outside of a weak headline number for durable goods. In stocks, investors have finally realized that even a soft landing means softer revenues and profits. Likewise, the bond market increasingly believes a soft landing means the Fed can now think about lowering rates sometime not far down the road - inflation numbers notwithstanding.
Recap of US Markets
STOCKS
Equities fell moderately over the week. Profit taking set in on Monday after a very strong prior week. Investors also were reconsidering whether they had been too bullish about the PPI and CPI numbers the prior week. On Tuesday we had relatively neutral Fed speak from the Atlanta Fed's Guynn but Moskow of the Chicago Fed rattled the markets with suggestions that the Fed may need to reconsider hiking interest rates with core inflation still too high. Weaker-than-expected existing home sales figures pulled down equities on Wednesday. Thursday, equities couldn't rally from Wednesday's drop as negative numbers for new home sales and the headline number for durables orders kept the markets soft. Friday ended the week on a sluggish-but-mixed note as the biggest excitement offered no excitement at all as Fed Chairman Bernanke, giving a speech on the international economy at the annual Fed conference at Jackson Hole, Wyoming, offered no comments on monetary policy.
For the week, all major equity indexes were down. The Dow was down 0.9 percent; the S&P 500 0.6 percent; the Nasdaq 1.1 percent; and the Russell 2000 1.7 percent.
Year-to-date, the Nasdaq remains down at 2.9 percent. But other major indexes are positive with the Dow up 5.3 percent, the S&P 500 3.7 percent; and the Russell 2000 3.9 percent.
BONDS
Interest rates fell over the week but with most of the action on the long end. Trading has been light with many traders still on vacation. Last week's soft economic data helped to nudge long rates down. Plus, on Friday, the lack of any policy commentary by Fed Chairman Bernanke actually nudged rates down a little more.
Net for the week the yield curve was down although on the short end the dip was slight. The 3-month Treasury bill and the 2-year note edged down 1 basis point each. For the 3-year note through the 30-year bond, rates fell from 3 to 6 basis points.
The yield curve continues to invert on the short-to-medium term segments. In years past this clearly would have been seen as a strong warning of possible recession. Few see that as a likelihood at this point - believing that the drift down in medium and long-term rates indicates both a softening in the economy (specifically demand for borrowed funds) and an eventual decline in inflation. The short end remains up near fed funds.
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 continues downward, overhang weighs heavier
Economic indicators were sparse in the week. Two of the three main indicators focused on housing and confirmed a continued downward spiral in housing activity. Existing home sales for July came in at a 6.330 million annual rate - down 4.1 percent from June. Sales are now down 11.2 percent from June of last year.
The biggest issue for housing now appears to be supply on the market. Supply is now up to 7.3 months - a 13-year high. This is a sharp contrast to 4.6 months supply in July of last year.
The housing slowdown is appearing to cause a secondary effect on the household sector, slowing the economy. Home valuation growth rates are slowing as housing prices have slowed. The median price of an existing home is up only 0.9 percent on a year-on-year basis. This is having a negative impact on growth in home equity lines of credit which have, at least until now, added substantially to consumer spending. Based on Fed commentary, however, the Fed indeed appears to be counting on this effect to help slow the economy and ease it into a soft landing.
New home sales also continue in a downturn. New home sales fell 4.3 percent in July to 1.072 million from June's 1.120 million units. Supply of new homes for sale is not far from the same magnitude of overhang as for existing homes, jumping 1.1 percent in July to 6.5 months - an 11-year high. Supply for existing homes is at a 13-year high.
Last week's reports and other data continue to point to further weakness in housing in coming months. Employment growth has been sluggish. Interest rates have only eased somewhat in recent weeks but remain relatively high. Thirty year fixed rate mortgages currently are running at 6 percent, compared to about 5-1/4 a year ago. Likewise, the National Association of Realtor's housing affordability index is down 7.2 percent on a year-on-year basis for June. These factors and especially the supply overhand suggest further slowing in starts and also in sales of household durables such as washers and dryers.
Durables favorable despite headline
Last Thursday many in the markets focused on the headline number for durable goods orders - a showing that new orders dropped 2.4 percent in July after a revised 3.5 percent surge in June. This decline was far greater than expected. However, once one gets past the headline number, durables manufacturing is still in great shape other than isolated weakness in transportation - notably the auto industry. Excluding transportation, new orders actually advanced 0.5 percent in July following a 2.2 percent jump in June. Durables orders excluding transportation have been up in 10 of the last 12 months.
Durables strength was widespread outside of the transportation sector with gains seen in primary metals, machinery, computers & electronic parts, and other durables. Declines were seen in fabricated metal products, electrical equipment, and transportation equipment.
We also can continue to expect business equipment investment to support economic growth. New orders for nondefense capital goods rose 0.2 percent in July, following a 2.1 percent boost in June. Orders turn into shipments and eventually end up as part of the estimates for business equipment investment in GDP. Unfilled orders for nondefense capital goods are now up 32.1 percent on a year-on-year basis.
Unfilled orders excluding transportation are up 16.3 percent year-on-year - indicating that substantial forward momentum remains.
The bottom line
Housing came in somewhat weaker than expected while durables manufacturing is healthy other than isolated weakness in the auto sector. Certainly there will be secondary effects from housing on the overall economy. But housing and the auto sector do not appear to be pulling on the economy too greatly. Nonetheless, one should expect weakness in housing-related equities and for companies that are notably dependent on sales of household durables. However, given the likelihood of upward revisions to second quarter GDP, we probably have further to go for the soft landing than previously believed.
Looking Ahead: Week of August 28 to September 1
Next week is jam packed with data - especially for the all-important consumer sector. We will also get a retake on second quarter GDP to see what the baseline is for how far we need to go to get to a growth rate that will lower consumer price inflation.
Tuesday
Consumer confidence
The Conference Board's consumer confidence index surprisingly rose to 106.5 in July from 105.4 in June. Overall, the index remains moderate despite consumer concerns over high gasoline prices.
Consumer confidence Consensus Forecast for August 06: 103.0
Range: 99.0 to 104.5
FOMC minutes
At the August 8 FOMC meeting, the Fed ended 17 consecutive increases in the fed funds target rate. In so doing, the Fed heavily relied on its forecast for a slowing economy and decelerating inflation. The markets will be closely picking apart the FOMC minutes for additional insight into what will lead the Fed to reconsider additional interest rate increases or to move to a declining interest rate phase.
Wednesday
GDP
GDP rose a moderate 2.5 percent annualized gain in the second quarter, following a sharp 5.6 percent increase in the first quarter. Since last month, numbers have been stronger than assumed for shipments of business equipment, retail sales, and inventories and are expected to boost second quarter GDP. Will GDP be revised upward and if so will the markets see the economy's momentum as too strong' The consensus expects a significant upward revision to 3.0 percent for the second quarter.
Real GDP Consensus Forecast for preliminary Q2 06: 3.0 percent annual rate
Range: 2.8 to 3.2 percent annual rate
GDP deflator Consensus Forecast for preliminary Q2 06: 3.3 percent annual rate
Range: 3.3 to 3.4 percent annual rate
Thursday
Personal income and outlays
Personal income rose 0.6 percent in June following a 0.4 percent increase in May. The latest increase was led by the wages and salaries component which rebounded 0.6 percent following no change in May. However, July's employment gains were soft and are likely to lead to a more moderate increase for personal income in July.
The markets have been paying as much attention to the inflation numbers for personal consumption as to the income numbers. The core PCE deflator is an indicator the Fed watches closely, and recent gains have been notably above the Fed's inflation target zone. In June, the core PCE deflator was up 0.2 percent, following a string of 0.3 percent increases. On a year-on-year basis, the core rate rose to 2.4 percent from 2.2 percent in June.
Personal income Consensus Forecast for July 06: +0.5 percent
Range: +0.4 to +0.7 percent
Personal consumption expenditures Consensus Forecast for July 06: +0.2 percent
Range: +0.1 to +0.2 percent
Core PCE deflator Consensus Forecast for July 06: +0.2 percent
Range: +0.1 to +0.2 percent
Jobless claims
For the August 19 week initial jobless claims edged down 1,000 to 313,000. Continuing claims for the Aug. 12 week, which is the survey week for the monthly employment report, fell 9,000 to 2.492 million. These numbers still are on the soft side and suggest modest employment growth for August.
Jobless Claims Consensus Forecast for 8/26/06: 315,000
Range: 310,000 to 315,000
NAPM Chicago
Regional manufacturing indexes have generally been softer than the national industrial production numbers. In July, the Chicago purchasing managers index edged up to 57.9 from 56.5 in June. However, the orders index showed somewhat more strength, rising almost 3 percentage points to 60.0. But what is still keeping market attention is the prices paid index, which remained high at 86.8 compared to 89.0 in June.
NAPM-Chicago Consensus Forecast for August 06: 56.1
Range: 55.0 to 58.0
Factory orders
Factory orders rose 1.2 percent in June, following a 1.0 increase in May. However, last week July durables orders dropped 2.4 percent in July and this will show up in the July numbers for overall factory orders. This report should be a nonevent since most of weakness in July's durables was in motor vehicles and in civilian aircraft. We will simply see small revisions in durables and find out how the small nondurables component is doing. At the end of the day, durables excluding transportation will still be quite healthy - indicating continued gains in manufacturing.
Factory orders Consensus Forecast for July 06: -1.0 percent
Range: -2.3 to -0.8 percent
Friday
Nonfarm payroll employment
Employment has been coming in on the soft side. Non-farm payrolls rose a modest 113,000 in July following gains of only 124,000 and 100,000 in June and May. On the other hand, earnings have been quite strong recently with sharp increases of 0.4 percent in both July and June. Even with slow employment growth, a key issue is whether labor markets are still too tight for current monetary policy. We need to see not just a continuation in moderate employment growth but a slowing in wage pressures..
Nonfarm payrolls Consensus Forecast for August 06: 130,000
Range: 90,000 to 180,000
Unemployment rate Consensus Forecast for August 06: 4.7 percent
Range: 4.6 to 4.8 percent
Average workweek Consensus Forecast for August 06: 33.9 hours
Range: 33.8 to 33.9 hours
Average hourly earnings Consensus Forecast for August 06: +0.3 percent
Range: +0.2 to +0.4 percent
Consumer sentiment
The University of Michigan's consumer sentiment index fell to 78.7 in July from 84.7 the prior month. This is the lowest level for consumer sentiment in 2006. Given that July's weakness was in the expectations component, we may see additional weak readings in the overall index in coming months.
Consumer sentiment index Consensus Forecast for final August 06: 79.0
Range: 78.7 to 80.0
ISM manufacturing index
According to the Institute for Supply Management, manufacturing picked up somewhat in July with the ISM index rising to 54.7 from 53.8 in June. As with the regional surveys, prices were a big issue. The prices paid index was up 2 percentage points to 78.5 in July - a very lofty level. Input prices are a remaining concern for the Fed.
ISM manufacturing index Consensus Forecast for August 06: 54.5
Range: 50.5 to 57.0
Construction spending
Last month we saw divergence in components of construction spending. While overall construction outlays rose 0.3 percent in June, private residential construction fell 1.0 percent and private non-residential construction jumped 2.7 percent. We can expect residential outlays to continue to slip in line with starts and housing sales, but will nonresidential construction continue to be healthy'
Construction spending Consensus Forecast for July 06: 0.0 percent
Range: -0.5 to +0.7 percent
Motor vehicle sales
Sales incentives have helped nudge up motor vehicle sales as U.S.-made vehicle sales rose to a 13.0 million unit annual rate in July from 12.5 million in June. With slowing employment growth, it is going to be difficult to keep up this sales pace without significant discounting.
Auto sales Consensus Forecast for August 06: 12.7 million-unit rate
Range: 12.6 to 13.0 million-unit rate
Markets drift as manufacturing offsets housing
