News this week on oil and inflation could have have hurt the market more dramatically than it did. But investors tended to ignore the least savory information (such as the FOMC minutes which suggested that the Fed had not necessarily completed its rate hikes) and focused on positive earnings news which came now and then over the course of the week.
On the whole, equity prices continue to rise from year-end levels. The Dow is up 3.2 percent and the S&P 500 3.3 percent. Thus far, these two blue chip indicators are moving in tandem. The Nasdaq composite index is up 3.7 percent from year-end, showing only a marginal out performance of the blue chip market. In contrast, the Russell 2000 is up a whopping 9.4 percent from year-end levels. The small cap market rules!
BONDS
The FOMC minutes from the January 31 meeting did not really reveal anything new about Fed policy. And while the bulk of the FOMC membership remains unchanged since January 31, more than just the Fed chairman has been replaced. Indeed, a few changes will take place at the March meeting. Federal Reserve Vice Chairman Roger Ferguson tendered his resignation and will not attend the March 27-28 meeting, as is the customary practice. However, Kevin Warsh, Bush's new nominee for governor, was sworn in today. Randall Kroszner, another Bush appointment, was not yet sworn in but will soon become a governor as well. Due to Ferguson's resignation, the Board will still be one member short. In addition, Philadelphia Fed President Anthony Santomero announced earlier this year that he plans to retire March 31, and a search is in progress to replace him.
In the meantime, the yield curve inversion is the main topic of conversation in the financial markets. Fed officials continue to claim that the yield curve is not predicting a recession. In fact, an inverted yield curve has almost always predicted a recession, but there have been one or two exceptions. It always (always!) makes me nervous to hear the phrase "this time is different". However, changes have occurred in the capital markets, and many more Asian countries than ever before (China) are buying our long-term Treasury securities. A recent Fed study found that foreign purchases have kept 10-year Treasury yields down by roughly 50 basis points. This hypothesis has some merit and should not be discounted.
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
ENERGY PRICES SURGE IN JANUARY
The consumer price index jumped 0.7 percent in January after declining a cumulative 0.8 percent in the two previous months. Energy prices once again rose, up 5 percent in January after decreasing 2.1 percent in December and 8.1 percent in November. Consumers would have seen a worse scenario without fuel oil prices which fell 1.2 percent for a third straight monthly drop. On the other hand, piped gas and electricity posted a 4.2 percent gain for the month. Overall, fuels and utilities are up 19.1 percent from year-ago levels. This winter has been mild, and many pundits have noted that consumers' utility bills didn't rise as much as expected. Pump prices have risen, though: the CPI included a 6.2 percent spike in motor fuel prices. These prices are up 27.4 percent from a year ago. Remember we were also complaining a year ago of the large gains in pump prices.
Food prices increased 0.5 percent in January, the largest monthly gain since April 2005. Within this group, fruits & vegetables jumped 1.7 percent and fats & oils spurted 1.4 percent. Fruits and vegetable prices have actually been posting steady increases and were 6.4 percent above year ago levels in January. Prices of most other food groups posted modest year-over-year gains and total food prices are up 2.6 percent over a year ago. That is less than the yearly rise in the total CPI (+4.0 percent) and is nearly on par with the yearly rise in the core CPI (+2.1 percent).
The core CPI (excluding food and energy prices) increased 0.2 percent in January, in line with average monthly gains going back several years. (The only exception in 10 years was 2003 when the core CPI averaged monthly gains of 0.1 percent instead of 0.2 percent.) While the average increase has not varied much, there is no question that price increases among various components are not identical. In January, the largest year-over-year gain comes from the transportation sector (remember this includes gasoline prices) which is up 7.3 percent. Within this category, new vehicle prices are down 0.4 percent from year ago levels, but public transportation is 7.6 percent higher. Used car and truck prices are 1.3 percent higher than last January.
Housing and medical care costs are running 4.3 and 4 percent, respectively, above year ago levels. Housing includes energy components as well, which are boosting the total. Shelter costs (includes rent) are up 2.6 percent but fuels & utilities are 19.1 percent higher than last year. Looking at medical care costs, the largest gains are in hospital and related services (+5.2 percent); medical care commodities (drugs) are 3.8 percent higher than a year ago.
Education and communication costs are up 2.7 percent from year ago levels - where education costs are up 6.4 percent but communication costs are down 1.1 percent. Within the communication component, personal computers & equipment are down 17.1 percent from year-ago levels. Other goods and services are up 2.9 percent from a year ago, reflecting a 4.3% rise in tobacco.
Apparel prices are down 1 percent from year-go levels with declines in all apparel (men's, women's and children) except for footwear, which are up 2.4 percent from a year ago.
It is always interesting to talk about the purchasing power of our dollar in social situations. While the Federal Reserve, market players and economists tend to focus on the so-called core components, most average consumers will focus on food and energy prices - because it makes up nearly one-quarter of their budget. Individuals with children in college are forced to focus on the high costs of education. The aging population needs to consider health care costs as well. Except for food, all of these items are more than the overall inflation rate.
The core inflation rate at 2.1 percent is not far off from the Fed's desired level. Indeed, once one converts this fixed basket price to the core PCE deflator, which reflects a variable basket of goods, it is likely that the core rate will be under 2 percent. But consumers in the real world can't exclude food and energy from their budgets. This means that real incomes are deteriorating faster than suggested by the so-called core. And that affects purchasing power.
DURABLE GOODS DON'T BENEFIT FROM WARM JANUARY
Advance durable goods orders plunged 10.2 percent in January, nearly (but not quite) offsetting the cumulative gains of the past three months. According to the Commerce Department, the 20 percent drop in nondefense capital goods orders, considered a barometer of capital spending, was a record drop since the series began in 1992. I didn't see anyone mention that the 22.1 percent spurt in nondefense capital goods orders in November was a record gain - but it was. Aircraft orders are extremely volatile from one month to the next. And the 194.2 percent gain in aircraft orders in November was followed by declines in December (6 percent) and January (78 percent). This portion of the report is hardly cause for alarm.
Indeed, excluding transportation, new orders rose 0.6 percent in January after gaining 1.9 percent in December. New orders for primary metals increased 0.4 percent while new orders for fabricated metals gained 0.6 percent during the month. Electrical equipment orders jumped 2.7 percent. Unfortunately for the manufacturing sector, these three components make up only about 25 percent of the total. Transportation machinery and computers & electronic products account for roughly 58 percent of durable goods orders - and these were decidedly down.
Some analysts mentioned the "r" word - recession. There is no question that durable goods new orders are a leading indicator of manufacturing activity. However, one month's data do not signal a trend. The primary reason for the drop in new orders stems from the volatile aircraft component. Boeing is not worried about aircraft orders. Today's front page of the Seattle Post-Intelligencer focused on their great earnings and hefty bonuses for their workers.
Regular readers of Simply Economics might remember that I have noted on previous occasions that the aircraft sector appears to be the growth engine of durable goods orders - and on its own - it isn't enough to keep production humming. That said, the pattern of new orders over the past two years appeared to focus strength in the second half of the year. I would not get prematurely concerned about the January drop in orders, but it certainly makes February more important. If orders (outside the aircraft sector) continue to fall, it could point to a more sustained slowdown in manufacturing.
The Bottom Line
Economic indicators showed super-sized change in January. However, beneath the surface, the inflation news was not as scary as the 0.7 percent hike in the CPI suggested. Durable goods orders plunged - and many pundits noted the record declines. But pundits also neglected to mention record increases in previous months. While the January durable goods report is by no means satisfactory for total manufacturing growth, a February rebound would make it palatable.
In contrast to this past week in which few key economic indicators were reported, the upcoming week will be filled with news. Market players will be monitoring the revision to fourth quarter GDP and the ISM surveys. The housing indicators are likely to be misleading - with oversized gains to match unseasonably warm weather in January.
Looking Ahead: Week of February 27 to March 3
Monday
New single-family home sales rose 2.9 percent in December to a 1,269,000-unit rate. The MBA purchase index was up in January over the December average reflecting a warmer-than-average month. Keep in mind that January figures will be overblown due to unseasonably warm weather - and this goes double for the housing market.
New home sales Consensus Forecast for Jan 06: 1,278,000-unit rate
Range: 1,200,000 to 1,330,000-unit rate
Tuesday
The Commerce Department's advance estimate revealed that real GDP expanded at a sluggish 1.1 percent rate in the fourth quarter of 2005 with weakness in consumption expenditures and investment spending. While fourth quarter figures are generally old news, market players will be interested in seeing whether or not the figures will be revised up significantly.
Real GDP Consensus Forecast for Q4 05: 1.6 percent annual rate
Range: 1.4 to 2.0 percent annual rate
GDP deflator Consensus Forecast for Q4 05: 3.0 percent annual rate
Range: 2.9 to 3.3 percent annual rate
The Conference Board's consumer confidence index rose almost 3 percentage points in January to 106.3. The University of Michigan's consumer sentiment index fell in early February and this bodes poorly for The Conference Board's attitude survey. However, these two surveys can be at odds with one another.
Consumer confidence Consensus Forecast for Feb 06: 104
Range: 99.8 to 107
Existing home sales declined 5.7 percent in December to a 6,600,000-unit rate. The MBA purchase index was up in January over the December average reflecting a warmer-than-average month. Keep in mind that January figures will be overblown due to unseasonably warm weather - and this goes double for the housing market.
Existing home sales Consensus Forecast for Jan 06: 6.75 million-unit rate
Range: 6.50 to 6.90 million-unit rate
The NAPM-Chicago's business barometer fell more than 2 points in January to 58.5. This index, which measures both manufacturing and non-manufacturing activity in the Chicago region, is often considered a leading indicator for the ISM manufacturing index. The New York and Philadelphia Fed surveys were higher in February than in January.
NAPM-Chicago Consensus Forecast for Feb 06: 59
Range: 56.5 to 60
Wednesday
Personal income increased 0.4 percent in December, about on par with recent average monthly gains. Look for a similar gain in January based on the employment situation. Personal consumption expenditures rose 0.9 percent in December despite only a small increase in nondurable goods. The retail sales report showed that consumption expenditures surged in January.
Personal income Consensus Forecast for Jan 06: 0.6 percent
Range: 0.5 to 0.8 percent
Personal consumption expenditures Consensus Forecast for Jan 06: 1.0 percent
Range: 0.7 to 1.5 percent
The ISM manufacturing index declined 1.2 points in January to 54.8 from December's level. The New York Fed's business outlook survey was unchanged in February, but the Philadelphia Fed survey increased during the month. These two Fed surveys are considered leading indicators for the ISM survey.
ISM manufacturing index Consensus Forecast for Feb 06: 56
Range: 55 to 57
Construction spending increased 1 percent in December after rising 0.5 percent in November. January construction gains are likely to be oversized based on all the other January housing figures.
Construction spending Consensus Forecast for Jan 06: 1.5 percent
Range: 0.7 to 2.5 percent
Domestic motor vehicle sales jumped 5.9 percent in January to a 14.4 million-unit rate after increasing 9.7 percent in November. Domestic cars were sold at a 6.6 million-unit rate and light trucks were sold at a 7.8 million-unit rate in January.
Domestic vehicle sales Consensus Forecast for Feb 06: 13.2 million-unit rate
Range: 12.7 to 14.1 million-unit rate
Thursday
New jobless claims fell 20,000 in the week ended February 18 to 278,000, bringing the 4-week moving average down to 281,750. According to Labor Department officials, there were no special factors accounting for the drop and no state reported that the East Coast blizzard affected the data. The week ended February 25 includes a holiday - and this makes the figures more difficult to adjust for seasonal variation.
Jobless Claims Consensus Forecast for 2/25/06: 285,000
Range: 265,000 to 315,000
Friday
At the mid-February reading, the University of Michigan's consumer sentiment index decreased almost 4 points to 87.4. Perhaps consumers are feeling the impact of higher loan rates these days and are still unhappy about high gas prices.
Consumer sentiment Consensus Forecast for Feb 06: 87.5
Range: 87 to 89
The business activity index from the ISM non-manufacturing fell more than 4 percentage points in January to 56.8. While the index level is not exceptionally high, it still reflects expanding business activity.
Business activity index Consensus Forecast for Feb 06: 58.6
Range: 56.5 to 60
Looking beneath the headlines
