Economic indicators, oil prices, and Fed Chairman Ben Bernanke dominated the news this week. Bernanke's seemingly dovish comments that the Fed may pause their rate hikes in order to assess economic conditions and the impact of past policy changes were viewed in a friendly light by most markets this week. However, market activity was not uniform this week. For instance, the Dow and the S&P 500 generally performed better than the Nasdaq composite and the Russell 2000 this week. Friday in particular, Microsoft news that it spent more money on its Internet operation to combat Google led to a plunge in its stock price and depressed the Nasdaq index.
Looking at the monthly figures, the Dow posted the largest gain in April (2.3 percent) followed by the S&P 500 (1.2 percent) and the Wilshire 5000 (1.0 percent). The Nasdaq composite index fell 0.7 percent and the Russell 2000 dipped 0.1 percent.
The April activity has shifted the winners and losers a bit among the various stock indexes. Year-to-date, the small cap market, measured by the Russell 2000, continues to outperform the large cap sector with a 13.6 percent gain. But the Dow Jones Industrials and the Wilshire 5000 are both up 6.1 percent from year-end. The other blue chip index, the S&P 500, is showing the smallest year-to-date gain of 5 percent. The Nasdaq composite index is up 5.3 percent from year-end.
BONDS
There appears to be some shifting on rate hike views now that Fed Chairman Ben Bernanke lobbed out a new option when he was testifying before the Joint Economic Committee. Before Bernanke's testimony, the thinking was that the Fed would either stop after a May hike or after a June hike. Bernanke indicated that the Fed could indeed pause to see how past rate hikes were affecting the economy. Now, everyone continues to believe the Fed will raise the funds rate to 5 percent at the May 10 meeting, but now the June meeting is in question as is August. Pausing is not the same as stopping, but was still viewed in quite a positive light by market players this week.
Yields rose across the board in April relative to March on strong economic growth, potential inflationary pressures and the prospect of further, if limited, Fed rate hikes. Finally, long-term rates are moving higher, and although the yield curve is still relatively flat, it appears to have a slight upward tilt.
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
Q1 GDP DELIVERS AS PROMISED
The Commerce Department's initial estimate of real GDP growth matched economists' predictions and grew at a 4.8 percent rate in the first quarter after the fourth quarter's meager 1.7 percent rate. Economists across the board had predicted a first quarter recovery the minute they saw the fourth quarter data several months ago, and they were right! Final sales, a measure of aggregate demand rather than production, grew at a whopping 5.4 percent rate, the best showing in four quarters. Even GDP growth posted the strongest quarterly rate in ten quarters.
A spurt in personal consumption expenditures led the growth, due primarily to a rebound in durable goods spending. Taking the average of growth for the fourth quarter of 2005 and first quarter of 2006, we see that consumer spending increased at a moderate 3.2 percent rate, less than the 10 previous quarters when consumer spending averaged annualized growth of 3.9 percent per quarter. It may very well be that consumer spending is actually slowing down these days as consumers face hefty gasoline bills.
Business fixed investment grew at a whopping 14.3 percent rate in the first quarter, the best showing since the second quarter of 2000. The bulk of the gain was in equipment and software spending, though investment on nonresidential structures picked up steam as well. Increased capital spending always bodes well for the economy. Residential investment spending only advanced at a 2.6 percent rate, reflecting the moderation in the housing market. Inventories were accumulated at a slower rate than in the previous quarter and thus acted as a drag on GDP growth in the first quarter.
Exports grew at a healthy 12.1 percent rate in the first quarter, but imports grew at a 13 percent rate. As a result, the net export balance deteriorated by more than $20 billion and was also a drag on GDP growth. Both inventories and net exports have a greater chance of being revised in subsequent GDP estimates since the data are not complete when the Bureau of Economic Analysis compiles the advance estimate.
The GDP deflator increased at a 3.3 percent rate in the first quarter, slightly less than in the fourth quarter. The PCE deflator increased at a 2 percent rate, nearly one percentage point lower than in the fourth quarter. However, government workers typically get cost-of-living adjustments in the first quarter, so the deflator tends to get boosted by the once-a-year wage gains.
EMPLOYMENT COST INDEX MODERATES
The employment cost index increased 0.6 percent in the first quarter after rising 0.8 percent in the two previous quarters. Consequently, this results in a year-over-year gain of 2.8 percent in the first quarter of 2006, the slowest year-over-year pace since the first quarter of 1997. Wages and salaries are holding their pace - rising 0.7 percent in the first quarter and posting a 2.7 percent year-over-year gain. Indeed, the yearly rise has accelerated from the past several quarters. The sharp improvement in the employment cost index came from slower growth in benefits costs, which were up 0.5 percent in the first quarter, the smallest quarterly gain in several years. It brought down the year-over-year gain to 3.4 percent, compared with a 4.5 percent year-over-year gain in the fourth quarter and 5 percent in the first half of 2005.
There appears to be an interesting disconnect between the employment cost index and the GDP deflator. Notice that year-over-year changes in the GDP deflator and the employment cost index mostly appear to move in tandem. From time to time, slight discrepancies occur. For instance, the ECI accelerated in 1997 and 1998 even as the deflator was moderating. But the differences are small - until the most recent period. Notice the sharp downward trend in the employment cost index and the acceleration in the GDP deflator. Total compensation costs are not accelerating as rapidly as the GDP inflation rate. One would expect the employment cost index to move with the deflator, but also accelerate in a period of healthy growth and full employment. Fed officials have voiced their concerns about tight labor markets that could give rise to wage and price pressures. We are having some price pressures, but it doesn't appear that we are facing wage pressures. I have seen several articles lately suggesting that U.S. workers are not benefiting from productivity growth. Martin Wolf of the Financial Times recently covered this topic based on some NBER working papers.
Incidentally, the March 2006 ECI release includes some major revisions to the data. Aside from annual seasonal adjustment changes, major changes include a reclassification of industry classifications and changes to definitions. For instance, severance pay and supplemental unemployment benefit plans which were previously included in total compensation and benefits are no longer collected. A new series was added for "excluding incentive paid occupations." Fixed employment weights were updated and new series were added for census divisions.
DURABLE GOODS ORDERS RECOVER
Durable goods orders jumped 6.1 percent in March after gaining 3.4 percent in February and managed to offset the 8.9 percent loss posted in the first month of the year. As a result, the average monthly gain in new orders squeaked out at +0.2 percent per month. It is certainly not as good as the two previous years, but it is early yet.
It should come as no surprise that aircraft orders were the primary driver for the March gain. However, in contrast to previous months, when it seemed to be the only impetus behind manufacturing, orders for most major components posted gains for the month. For instance primary metals rose 1.1 percent, fabricated metals increased 1.3 percent, machinery orders jumped 7.5 percent as did new orders for computers and electronics. Transportation orders, which include more than aircraft, gained 14 percent. New orders for electrical equipment and appliances fell 1.8 percent, however. If we see a few more months of new orders posting widespread gains, it is more likely that industrial production will pick up steam in 2006.
MARCH HOME SALES RISE
Existing home sales, which also include condos & coops, increased 0.3 percent in March to a 6,920,000 unit pace. New home sales jumped 13.8 percent to a 1,213,000-unit rate. While the March gain in new home sales managed to surpass January and February levels, sales of new homes were still down 7.2 percent from a year earlier. Sales of existing homes are only 0.7 percent lower than year ago figures. But there is no question that home sales have softened in recent months relative to the June 2005 peak. There is also no question that housing becomes less affordable as interest rates rise.
Prices are no longer uniformly skyrocketing. Just as the Fed is making its decisions more data-dependant, housing appreciation - or depreciation - is more than ever location dependent. The aggregate data reveal that the median sales price of an existing home remain unchanged at $218,000 in March from the February average, but was down from $220,000 in January. The median price was still 7.4 percent higher than a year ago. The average sales price increased slightly in March from the February average to $266,000, but was down from the January average of $268,000. The March 2006 average price was 4.7 percent higher than a year earlier.
New home prices are revealing a slightly different story. March's median price of $224,200 was 6.5 percent lower than February's median price and the March price was 2.2 percent lower than March 2005. The average price of a new home was $279,100 in March, 7.1 percent lower than in February and 3.6 percent lower than last year. These prices are not the best gauge of a very location-specific market, but they do reflect the fact that the housing market is no longer booming at a gangbuster pace. It doesn't mean that home prices are depreciating rapidly. It could also reflect the fact that consumers are buying smaller, more affordable homes today than last year since mortgage rates have increased. But the robust home appreciation of the past few years may soon be a distant memory in many regions of the country.
The Bottom Line
Market players had plenty of economic news to digest this week - along with the comments of Fed Chairman Ben Bernanke. Economic news generally revealed that economic activity was healthy in the first quarter, a sharp improvement over the pace of the fourth quarter. Real GDP growth delivered as promised by pundits. More interesting were Ben Bernanke's comments before the Joint Economic Committee as he indicated that the Fed might pause in their rate hikes as they try to assess economic conditions and the impact of past monetary policy.
Bernanke is delivering a consistent message: Fed action is data dependent. That means that the Fed is monitoring all available indicators and reassessing their views as data comes in. It is the smart thing to do given that the Fed is certainly in their neutral zone with regards to the fed funds rate target, and they may be intending to tighten monetary policy further. Ahem, they are firming monetary policy; according to pundits, tightening is a term of the past.
The upcoming week will see a slew of data - including the April employment situation.
Looking Ahead: Week of May 1 to May 5
Monday
Personal income increased 0.3 percent in February, slower than in the two previous months. Look for a similar gain in March based on the employment situation. Personal consumption expenditures rose 0.1 percent in February dampened by durable and nondurable goods spending. The retail sales report showed that consumption expenditures rose moderately in March.
Personal Income Consensus Forecast for Mar 06: 0.4 percent
Range: 0.3 to 0.6 percent
Personal Consumption Expenditures Consensus Forecast for Mar 06: 0.4 percent
Range: 0.3 to 0.6 percent
The ISM manufacturing index fell 1.5 points in March to 55.2 from February's level. The New York Fed's business outlook survey fell sharply in April, but the Philadelphia Fed survey edged up modestly during the month. The business barometer from the NAPM-Chicago declined more than 3 points in April. These three indicators are considered leading indicators for the ISM survey.
ISM Manufacturing Index Consensus Forecast for Apr 06: 55
Range: 53 to 56.5
Construction spending increased 0.8 percent in February, posting the eighth consecutive monthly rise. March construction could be down based on the recent declines in housing starts.
Construction Spending Consensus Forecast for Mar 06: 0.4 percent
Range: 0.0 to 0.7 percent
Domestic motor vehicle sales fell 1.5 percent in March to a 12.9 million-unit rate after declining 9 percent in February. Domestic cars were sold at a 5.1 million-unit rate in March while light trucks were sold at a 7.8 million-unit rate.
Domestic Vehicle Sales Consensus Forecast for Apr 06: 13.1 million-unit rate
Range: 12.9 to 13.3 million-unit rate
Wednesday
The business activity index from the ISM non-manufacturing inched up 0.4 percentage points in March to 60.5 after posting a larger rise in February. While the index level is not exceptionally high, it still reflects expanding business activity.
Business Activity Index Consensus Forecast for Apr 06: 59.7
Range: 58 to 62
Factory orders inched up 0.2 percent in February, but look for a sharp reversal in March. Durable goods orders jumped 6.1 percent during the month, primarily due to increased aircraft orders. In contrast to previous months, orders outside the transportation sector posted healthy gains in March. Perhaps this improvement will transfer to the nondurable goods manufacturing sector as well.
Factory Orders Consensus Forecast for Mar 06: 4.0 percent
Range: 1.5 to 4.3 percent
Thursday
New jobless claims rose 11,000 in the week ended April 22 to 315,000, and the 4-week moving average increased to 308,500. Thus far, April claims are roughly on par with the March average.
Jobless Claims Consensus Forecast for 4/29/06: 310,000
Range: 300,000 to 315,000
The Labor Department initially estimated that nonfarm productivity fell at a 0.5 percent rate in the fourth quarter, after growing at a 4.2 percent rate in the third quarter. Given the much stronger GDP growth in the first quarter relative to the fourth quarter, it is likely that productivity growth will show improvement in the first quarter. Unit labor costs rose at a 3.3 percent rate in the fourth quarter. Typically an improvement in productivity comes in tandem with an improvement in unit labor costs , that is, unit labor costs should grow more slowly as productivity grows more rapidly.
Nonfarm Productivity Consensus Forecast for Q1 06: 3.0 percent rate
Range: 2.5 to 4.0 percent rate
Unit Labor Costs Consensus Forecast for Q1 06: 1.3 percent rate
Range: 0.7 to 2.2 percent rate
Friday
Nonfarm payroll employment increased 211,000 in March. This was roughly on par with the February gain and an improvement over the December and January gains. The civilian unemployment rate inched back down to 4.7 percent in March and remains at historically low levels. Fed officials are concerned that the jobless rate is reflecting tight labor markets, which could potentially set the stage for rapidly accelerating wage gains.
Nonfarm Payrolls Consensus Forecast for Apr 06: 200,000
Range: 175,000 to 235,000
Unemployment Rate Consensus Forecast for Apr 06: 4.7 percent
Range: 4.6 to 4.7 percent
Average Workweek Consensus Forecast for Apr 06: 33.8 hours
Range: 33.8 to 33.9 hours
Average Hourly Earnings Consensus Forecast for Apr 06: 0.3 percent
Range: 0.2 to 0.3 percent
Consumer installment credit increased $3.3 billion in February after growing more rapidly in January. But February sales were down from the robust January pace. While retail sales were not quite so robust in March as they were in January, they were certainly an improvement over February. This could contribute to consumer credit growth, although motor vehicle sales fell modestly in March.
Consumer Credit Consensus Forecast for Mar 06: $4 billion
Range: $2 to $5 billion
Will economic growth prevent rate hike "pause"'
