The more commonly quoted market indexes, the Dow Jones industrials and the Nasdaq composite index, are performing much worse. The Dow decreased 1.3 percent in April, its second monthly decline and now stands 2.2 percent below year-end levels. The Nasdaq composite index has now declined for three of the past four months - an inauspicious way to begin the new year! The composite index fell 3.7 percent in April and is now 4.2 percent below year-end levels.

Aside from continued terrorist attacks around the world, which are clearly contributing to the negative psychology in the markets, equity investors must determine what will hold more sway: Will higher interest rates hurt companies' Or will these companies benefit from stronger economic growth in coming months' If rates only rise 25 or 50 basis points in the next year, it is likely that a robust economic environment will add more to the bottom line of the profit ledger than higher interest rates will subtract. Based on the market declines in the past few months, it appears that equity investors believe that all the good news was factored in the market last year. Did the 2003 gains lead to over-valued markets or are investors over-reacting to the inevitable rate hikes that must come this year'

BONDS
Treasury yields dipped on Friday but the declines were small relative to April's week-to-week upward creep, a sell-off triggered by the 308,000 rise in March employment. This set the Treasury market on edge: the Fed would have to start raising rates eventually. A few weeks later, Fed Chairman Alan Greenspan testified before Congress and mentioned the words "rate" and "increase" in the same sentence. Once again, Treasury yields jumped. After all was said and done, yields were up across the board in April, with larger gains at the short end (2-year, 3-year and 5-year) and smaller increases at the long end (10-year, 30-year). The increases range from 50 basis points to 83 basis points. Clearly, more than one rate hike is already factored in the market.

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

Weaker than expected, albeit strong growth
The Commerce Department's initial estimate revealed that real GDP grew at a 4.2 percent rate in the first quarter of the year, not unlike the fourth quarter's 4.1 percent pace. Some differences did emerge from the composition of growth. Real final sales increased at a 3.9 percent rate in Q1, faster than Q4's 3.4 percent pace. Personal consumption expenditures, despite a drop in durable goods spending, increased at a 3.8 percent rate after growing at a solid but slower 3.2 percent rate in the fourth quarter. Spending on structures declined at a 6.5 percent rate, a much larger drop than in the previous quarter, and spending on equipment & software grew at a healthy 11.5 percent rate but slower than Q4's 14.9 percent pace. The net export deficit widened slightly although both imports and exports posted gains for the quarter. All in all, it was a solid quarter but economists had predicted that real GDP would advance by 5 percent in the first three months of the year, and the slower pace discouraged equity investors.

The GDP deflator accelerated in the first quarter with a 2.5 percent rate of growth, up from a 1.5 percent pace in the two previous quarters. Often, the deflator will accelerate in the first quarter as government workers receive cost of living raises. But this time, the PCE deflator jumped very sharply, from a 1 percent pace in Q4-03 to a 3.2 percent rate in Q1-04. This was partly due to higher energy prices, but prices of services accelerated and durable goods prices fell significantly less than in the previous several quarters. Most Fed officials on the chicken circuit have indicated that they don't believe inflation is a problem yet. However, prices are undoubtedly rising more rapidly than they have in the past year. One of these days, Fed officials might actually take notice.

ECI accelerates in quarter, not in year
The employment cost index jumped 1.1 percent in March, faster than the 0.8 percent gain posted in the fourth quarter. Not surprisingly, the spurt was almost entirely due to a 2.4 percent surge in benefits costs. Wages & salaries rose a modest 0.6 percent during the first three months of the year. For private sector workers, higher benefits costs were due to increased defined benefit retirement costs. For government workers, higher health care costs largely contributed to the higher benefits costs.

On a year-over-year basis, the ECI rose 3.8 percent, roughly in line with the previous quarter. Wages and salaries increased 2.5 percent, slower than the 2.9 percent gain recorded in the fourth quarter. Yearly benefits costs jumped 6.9 percent in the first quarter, accelerating from a 6.3 percent annual gain in the fourth quarter of 2003. On the whole, total compensation costs have remained stable over the past two years. This helps to hold down labor costs and boost corporate profits.

NAPM-Chicago jumps in April
The NAPM-Chicago business barometer jumped several points in April to regain a level of 63.9 percent. Gains were widespread across the various indexes in this survey of the Chicago region that encompasses both the manufacturing and non-manufacturing sectors. Production and new orders jumped during the month, as did supplier deliveries. Order backlogs and inventories also posted increases. Even the employment index increased - and managed to hop over the 50 percent mark that suggests growth rather than contraction.

A word of caution: Market participants have long favored the Chicago index as a predictor of the ISM manufacturing index, which is reported one business day later (May 3rd). Indeed, the chart above does suggest that the two series move in tandem. However, looking closely, one will see that the two series aren't a strict match each and every month. For instance, the Chicago index fell sharply in March, but the ISM manufacturing index managed a nice little gain. Chicago's April index is back where it was in February suggesting that the March dip was an aberration. Most market players are expecting the April ISM to jump because the Chicago index jumped. However, it would be wise to interpret this cautiously. Perhaps the ISM will only remain at last month's (healthy) level, or post a relatively slight hike, but not in the order of magnitude of the Chicago index.

Jobless claims decline in week, rise in month
Jobless claims declined in the week ended April 24 but are up in these first three weeks of April from the March average. Overall, claims are still on a downward trend but seem to have hit a plateau after declining for several months in 2003. The Conference Board's help wanted index dipped again in March after inching up in February. On the whole, the help wanted index is barely an inch above the bottom and does not suggest a healthy rise in want ads! On the whole, these two indicators are discouraging and don't point to another strong month in nonfarm payrolls such as we had in March. The market consensus calls for a healthy rise. A weaker-than-expected payroll number would certainly add excitement, but not always joy, to the equity, bond and foreign exchange markets!

Homebuyers favor low interest rates
New single-family home sales jumped 8.9 percent in March after dipping 1.1 percent in February. At the same time, existing single-family home sales increased a healthy 5.7 percent in March after posting a more moderate 2.2 percent gain in February. Both new and existing home sales are up sharply from a year ago. Indeed, at 5.45 percent in March 2004, the 30-year fixed mortgage rate was 30 basis points lower than it was at the same time a year ago. In 2003, the low mortgage rate of 5.23 percent wasn't reached until June. This year, it looks as though the low will indeed be March. In April, mortgage rates shot up 46 basis points! Rates are still lower than the August 2003 average of 6.26 percent but are closing in on that level. From an historical perspective, mortgage rates are low. But as they continue to inch higher, we are unlikely to see the big spurts in refinancing activity that have helped to boost consumer cash flow in the past few years. Also, fewer potential homebuyers will be entering the marketplace after the booming years of 2001, 2002 and 2003. That's not to say that home sales will plunge in 2004, but their most likely trend is lower, not higher.

The Bottom Line
Economic news was pretty good this week: home sales surged, real GDP grew at a respectable rate, consumer confidence remained in a tight range, and the NAPM-Chicago suggests that April business activity was on a strong path. Equity and bond investors remain concerned about the direction of monetary policy. There is no doubt that the Fed will have to raise rates at some point. Many bond investors already believe that the Fed has waited too long in raising the federal funds rate target and that inflationary pressures are a concern. Nonetheless, no one expects the Fed to raise rates at the May 4 meeting, although everyone expects a revision to the old statement.

The upcoming week is not only heavy on economic news, but it also incorporates an FOMC meeting AND the employment situation for April. Fasten your seatbelts because next week promises to be a roller coaster ride!

Looking Ahead: Week of May 3 to May 7

Monday
The ISM manufacturing index rose more than one point in March to reach 62.5 percent. Any level above 50 percent represents growth in the manufacturing sector and a level above 60 percent certainly points to a healthy pace of growth. Market players will also be monitoring the prices paid index, which jumped to 86 percent in March. Faster growth often leads to higher raw materials prices.

ISM manufacturing index Consensus Forecast for Apr 04: 63
Range: 60 to 65

Construction spending edged down 0.1 percent in February after decreasing 0.8 percent in January. This was, at least in part, due to the drop in housing starts during those months. Housing starts surged in March and this could help boost construction spending for the month as well.

Construction spending Consensus Forecast for Mar 04: 0.6 percent
Range: 0.0 to 1.0 percent

Motor vehicle sales have remained in a tight range in the past couple of months after surging last December. Domestic cars were sold at a 5.6 million-unit rate in March while light trucks were sold at a 7.6 million-unit rate. Perhaps improved labor market conditions have encouraged buyers to visit showrooms in April.

Light truck sales Consensus Forecast for Apr 04: 7.9 million-unit rate
Range: 7.8 to 8.2 million-unit rate

Auto sales Consensus Forecast for Apr 04: 5.7 million-unit rate
Range: 5.5 to 5.8 million-unit rate

Tuesday
Factory orders inched up 0.3 percent in February, offsetting a small portion of January's 0.9 percent drop. However, durable goods orders surged 3.4 percent in March after an upward revised 3.8 percent gain in February. This could help boost March orders and suggests a possible upward revision to February levels as well.

Factory orders Consensus Forecast for Mar 04: 2.5 percent
Range: 1.0 to 3.0 percent

The FOMC is meeting on Tuesday and will have much to discuss given the significant improvement in economic activity and labor market conditions since they last met in mid-March. Most analysts don't expect the Fed to raise rates at this meeting, although many are expecting that the statement will be revised - so that the words "unwelcome fall in inflation" will be stricken. Indeed, the statement may be revised entirely, though Fed officials seem to prefer small incremental changes in policy.

Fed funds target Consensus Forecast for May 04: 1.0 percent (unchanged)

Wednesday
The ISM non-manufacturing survey improved sharply in March. The business activity index, which gets most of the attention by market players, increased 5 points to 65.8. Any level above 50 percent points to an expanding economy. Index levels above 60 percent suggest a robust rate of growth.

ISM non-manufacturing business activity index Consensus Forecast for Apr 04: 65
Range: 62 to 69

Thursday
New jobless claims fell 18,000 in the week ended April 24 to 338,000. This brought the 4-week moving average to 346,500. While the decline in jobless claims was encouraging, the April average is higher than the March average.

Jobless Claims Consensus Forecast for 5/1/04: 335,000 (-3,000)
Range: 325,000 to 340,000

Nonfarm productivity expanded at a 2.6 percent rate in the fourth quarter of 2003. While this was a healthy pace, it appeared downright modest after the 9.5 percent hike recorded in the third quarter. Unit labor costs inched down at a 0.4 percent rate in the fourth quarter of 2003 after dropping at a 5.6 percent rate in the third quarter.

Nonfarm productivity Consensus Forecast for Q1 04: 3.5 percent rate
Range: 2.8 to 4.0 percent rate

Unit labor costs for Consensus Forecast for Q1 04: 0.0 percent rate
Range: -0.8 to +1.4 percent rate

Friday
Nonfarm payrolls increased 308,000 in March after a paltry 46,000 gain in February. Economists generally believe that the magnitude of increase in March was the first of many. The civilian unemployment rate edged up to 5.7 percent in March as an increase in the labor force outpaced a rise in household employment.

Nonfarm payrolls Consensus Forecast for Apr 04: 170,000
Range: 95,000 to 250,000

Unemployment rate Consensus Forecast for Apr 04: 5.7 percent
Range: 5.6 to 5.7 percent

Average workweek Consensus Forecast for Apr 04: 33.8
Range: 33.7 to 33.9

Average hourly earnings Consensus Forecast for Apr 04: 0.2 percent
Range: 0.1 to 0.3 percent

Consumer installment credit increased $4.1 billion in February, significantly less than the $15.8 billion spurt in January. Often consumer credit gains are tied to motor vehicle sales. Auto and truck sales were virtually unchanged in March although nonauto retail sales were healthy.