Economic growth fell at a faster pace in the fourth quarter.  The markets had a brief sigh of relief that the decline was not as bad as expected.  But the detail indicated that the contraction indeed was as bad as most had feared.

Recap of US Markets

STOCKS

This past week both earnings and economic data weighed on equities.  On the economic indicator front, home prices continued to plummet, new home sales hit a record low, durable goods orders fell again, consumer spirits are either at or near a record low, and GDP contracted sharply in the fourth quarter.  Also, the Fed’s FOMC statement indicated that the Fed still sees negative growth ahead.

Economic data did the most damage on Thursday with a very negative durable goods report combined with news of record low new home sales and a jump in unemployment claims.  Rumors that the Obama Administration’s plan to create a “bad bank” program had hit technical snags led stocks down on Friday along with discounting the not-as-bad-as-expected GDP report on the rise in inventories.

News from the corporate sector points to a continuing deep recession. Corporations, at least,  announced over 100,000 layoffs this past week alone, including Starbucks, Sprint, Boeing, Eastman Kodak, and Target.

Earnings disappointed more often than not.  Disappointing earnings stood out for Caterpillar, DuPont, Delta Air Lines, Starbucks, and Proctor & Gamble.  Topping estimates were Yahoo and Texas Instruments.  Declining home prices hurt bank stocks. 

Finally, it is such a statistic that it should not be overlooked - Exxon Mobil reported the largest yearly profit in U.S. history due to high oil prices, earning $45.22 billion in 2008 despite a fourth-quarter profit that fell 33 percent from a year ago.

Equities were down this past week. The Dow was down 0.9 percent; the S&P 500, down 0.7 percent; the Nasdaq, down 0.1 percent; and the Russell 2000, down 0.2 percent.

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.

BONDS

Treasury yields firmed this past week – especially for notes and bonds.  The week was laden with some $135 billion in debt being sold – a reminder of the ballooning federal deficit.  Treasury prices fell significantly on Wednesday and Thursday after the Fed failed to provide a timetable for its plan to buy government debt as a way to lower mortgage rates.  There also was disappointment that the Fed did not plan to immediately purchase longer maturity Treasuries.  Finally, comments by then designate-Secretary of the Treasury Tim Geithner that China is manipulating its currency rattled the bond market.  The U.S. depends on China to buy a significant portion of supply of Treasuries and if an angered China backs away from holding Treasuries, then prices will fall and rates jump.

For this past week Treasury rates were up as follows: 3-month T-bill, up 13 basis points, the 2-year note, up 15 basis points; the 5-year note, up 26 basis points; the 10-year bond, up 26 basis points; and the 30-year bond, up 30 basis points.

Heavy supply weighed on Treasury prices this past week while inflation concerns remain over the massive and building federal deficits and huge injections of liquidity into the financial markets.

OIL PRICES

Crude oil prices continue to be weighed down by any economic news reminding the markets of recession.  This past week, the big drop in prices for West Texas intermediate was over $4 per barrel on very bearish news on consumer confidence and on news that Shell would be selling some of its floating inventory.  Continuing declines in home prices, weaker durables orders, and a further drop in GDP did not help either.

Net for the week, spot prices for West Texas Intermediate dropped $2.97 per barrel to settle at $41.68 – and coming in $103.61 below the record settle of $145.29 per barrel set on July 3.

The Economy

The economy plunged further into recession in the fourth quarter.  Based on the latest data, nearly every sector is contracting.  Growth is at its worst since 1982.  Meanwhile, the Fed continues to look for additional ways to improve the credit markets and pump even more liquidity into the economy.

GDP decline accelerates

The recession is worsening, based on the Commerce Department’s numbers for fourth quarter GDP. For the final quarter of 2008, GDP posted a sizeable 3.8 percent decline and followed a 0.5 percent contraction the prior quarter. Probably the only good news about the report was that the decline was not as bad as feared - the market consensus had called for a 5.4 percent fall.  The fourth quarter drop was the worst quarterly decrease since a 6.4 percent fall in the first quarter of 1982.

Economic contraction has spread throughout the economy.  The all important consumer spending component dropped 3.5 percent annualized.  But the fourth quarter decrease was led by sharp declines in residential investment and also business investment in equipment & software.  Nonresidential structures investment dipped slightly. 

The fact that worldwide economic growth is falling hit the U.S. GDP numbers. Net exports no longer are contributing to growth as the real trade gap widened slightly. Worldwide recession led to a sharp decline in exports.  However, weak domestic demand also pulled down imports.  Government purchases were a mild positive but slowed sharply from the third quarter.

The biggest positive for the quarter was a rise in inventories – but that will weigh on production in coming quarters.  So, even the inventory positive is really a negative.  This can be seen in the final sales number for the fourth quarter.  Final sales fell an annualized 5.1 percent, after falling a 1.3 percent slip the prior quarter.  So, all of the unmet expectations for overall GDP were actually met if seen for final sales.

On the inflation front, lower oil prices pulled overall inflation down.  The GDP price index slipped an annualized 0.1 percent after gaining 3.9 percent in the third quarter. The headline PCE index was even weaker, dropping an annualized 5.5 percent after a 5.0 percent boost in the third quarter. Apparently, the retrenchment in consumer spending has worked its way to core PCE inflation which rose a modest 0.6 percent after 2.9 percent the previous quarter.

Year-on-year growth for real GDP in the fourth quarter dropped to minus 0.2 percent, compared to up 0.7 percent in the third quarter.

On an annual average basis, growth for 2008 slowed to 1.3 percent from 2.0 percent the year before.  Growth in the past year was the slowest since 0.8 percent for 2001.

Based on the latest quarter, the recession without a doubt is growing deeper and wider.  Nearly every major component of the economy is in decline.  The markets did not give the final sales number much attention but that is the most important number from the report.  The 5.1 percent fall in final sales, combined with the rise in inventories, indicates that forward momentum is still downward.

New and existing home sales come in mixed for December

The existing and new home sales reports pointed in completely opposite directions – but from very low levels of activity for both.  Surprisingly, existing home sales jumped 6.5 percent in December to a 4.740 million unit annual rate -- a gain that indicates lower mortgage rates are now boosting home sales. The jump cut nicely into supply on the market, resulting in 9.3 months of supply, down steeply from November's 11.2 months.

But the bad news is that it’s not just lower mortgage rates bumping up sales but lower prices. The median price fell 2.7 percent in the month to $175,600 with the year-on-year rate showing accelerating erosion at -15.3 percent -- a rate that the report says is probably the largest since the 1930s. The bad news for the rest of the economy is that falling home prices point to rising foreclosures and even greater stress on the banking system.

While the existing home sales numbers were a positive, an alternative view is that large seasonal factors during winter months artificially boosted very modest actual gains in sales.  Housing related statistics are notoriously unreliable during winter months.  In fact, new home sales add to the view that housing is still quite depressed.

New home sales fell 14.7 percent in December to a record low 331,000 annual unit rate from a sharply downward revised 388,000 in November   Details of the report offer more of the same. Supply on the market is at a record high of 12.9 months vs. 12.5 months in November. The median price for a new home plunged 6.0 percent from November to $206,500 and is down 9.3 percent from a year ago. Sales in the month showed contraction in all regions.

The bottom line for home sales is that the level of activity for both new and existing homes is still anemic.  Unsold inventories for both are still extremely high and will continue to weigh on starts.  Recovery in housing still has not arrived.

Durable goods show manufacturing continuing to fall

Almost every facet of the latest durable goods report shows the manufacturing sector continuing to worsen.  Durable goods orders in December fell again and it’s worse than the headline number suggests.  Durable goods orders declined another 2.6 percent in December, following a 3.7 percent decrease in November. Excluding the transportation component, new orders slipped 3.6 percent, after falling 1.7 percent the prior month.

The drop in November – as in October - was led by computers & electronics and by primary metals, which fell 7.2 percent and 6.9 percent, respectively. Fabricated metals and machinery also declined by 3.6 percent and 5.0 percent, respectively. 

On the positive side, electrical equipment posted a 9.4 percent rebound while transportation squeezed out a 0.6 percent bump up in new orders.  But the transportation rise was due to a 16.4 percent jump in defense aircraft—motor vehicles and nondefense aircraft dropped 5.2 percent and 43.6 percent, respectively.

Looking at other key facets of durables, forward momentum is increasingly downward.  Shipments have fallen five consecutive months, including a 0.7 percent drop in December.  Unfilled orders have been down three months in a row with December down 1.3 percent.  And now, inventories are weighing on production, rising 17 of the last 18 months, including 0.4 percent in December.  Nearly every facet of the durables report points to further contraction in manufacturing in the months ahead.

Also, the durables report pointed to sustained weakness in business investment and in exports for capital goods.  Nondefense capital goods orders have fallen for five consecutive months.  These orders fill business equipment needs both for U.S. businesses and for exports.  In December, overall nondefense capital goods orders dropped 5.9 percent but excluding aircraft dipped 2.8 percent.

Overall, the latest durables orders report shows a deeper contraction in the manufacturing sector. 

Consumers in glum mood

Both the Conference Board’s consumer confidence index and the Reuter’s/University of Michigan consumer sentiment index are at or near record lows in January. The Conference Board's index fell to a record low of 37.7 in from 38.6 in December. Weakness was centered in the present situation component but expectations were also extremely weak.

Meanwhile, the Reuters/University of Michigan consumer sentiment index was little changed at 61.2 in January, compared to a December reading of 60.1. Both the assessment of expectations and the assessment of current conditions, the two components of the headline index, were little changed.

The bottom line is that consumers are extremely worried about current and near-term economic conditions – notably the job market.  The numbers point out a key difficulty that any of the potential stimulus packages faces – boosting confidence in consumers so they are more willing to spend.

Leading indicators boosted by Fed liquidity injections

Well, you can’t say the Fed isn’t trying – and it’s showing up in leading indicators. The Fed has made massive injections of liquidity into the financial markets with the statistical result of really jacking up the money supply. And this surge in the money supply is what lifted the Conference Board's index of leading economic indicators in December by 0.3 percent. But without money supply, indications are in fact very negative with the report warning that the results point to "intense recession" through the spring.  Without the money supply contribution, the leading index would have fallen 0.7 percent.

The other notable positive in the leading index also reflected the Fed’s recession fighting activities – the yield spread added a modest positive contribution to the index due to the Fed pushing the fed funds rate down.

Factors pointing to economic decline include falling building permits, a falling factory workweek, faster vendor deliveries and rising unemployment claims.

The report's coincident indicator is showing the degree of the current economic contraction, with a 0.5 percent decline following a 0.3 percent decline in November.  The bottom line, however, is that without a little help from the real side of the economy, boosts in the money supply are not going to pull the economy out of recession.

The Fed holds steady but planning more quantitative easing

The December 15-16 FOMC meeting was a tough act to follow since the December meeting pulled the fed funds target rate essentially to zero. The January 27-28 meeting kept the target rate at the historically low range of zero to 0.25 percent, adding again that the effective fed funds rate is likely to remain in this range “for some time.”

What’s different from the last FOMC'  First, the FOMC stated that the economy has worsened – no surprise.  However, we will get an update on the Fed’s economic forecasts when the minutes are released on February 18 and markets will be looking to see when the Fed thinks recovery will begin.

The Fed sees inflation under control for now and, in fact, indicated for the first time this cycle that inflation may be too low.

"In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

The Fed reemphasized that it will be engaging in quantitative easing (though declining to use that phrase) in the near term to boost the economy.  The Fed is specifically focusing on select segments of the credit markets—mortgages, consumer credit, and small business credit.

"The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.”

"The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.”

What also stands out from the latest FOMC meeting is that there is a growing internal debate on the specifics of the quantitative easing.  While the FOMC stated that it is prepared to begin making purchases of long-term Treasuries, Richmond Fed’s Lacker dissented at the latest meeting, arguing that the Fed should actually begin such purchases immediately rather than simply being prepared.  So, the argument is should the Fed engage in broad-based quantitative easing or use focused easing of specific segments of the credit markets'  This issue is not going to go away soon.  Nonetheless, the Fed will continue quantitative easing in some form while the Obama Administration finalizes its proposals for fiscal stimulus.

The bottom line

The economy has fallen further into recession.  Company earnings are reflecting the weakness in the economy overall.  The big question is whether the economy is worse than expected.  Looking ahead, the consumer sector and housing sector will have to improve before the overall economy does.  But improvement in both of these sectors appears to be some time off as both may well be still worse than previously expected.

Looking Ahead: Week of February 2 through 6 

This coming week we have three market movers.  Two major consumer sector indicators bookend the week with personal income on Monday and the employment situation on Friday.  We also get an update on manufacturing with the ISM report on Monday.

Monday 

Sales of domestic motor vehicles were extremely weak in December but still edged up to a 7.7 million annual rate from November’s record low of 7.5 million units.  Heavy discounting and lower gasoline prices have not helped sales much due to the recession and worries that the automakers might become bankrupt. Overall, the year 2008 was quite ugly for U.S. producers.  Year-ago totals were down as follows: General Motors, down 22.7 percent; Ford, down 20.5 percent; and Chrysler, down 30.0 percent. 

Motor vehicle domestic sales Consensus Forecast for January 09: 7.7 million-unit rate

Range: 7.3 to 8.1 million-unit rate

Personal income in November slipped while spending has worsened. Personal income in November dipped 0.2 percent while the wages and salaries component decreased 0.1 percent. The really worrisome part of the report, however, was personal consumption expenditures falling another 0.6 percent after plummeting 1.0 percent in October. But there was good news on the inflation front.  The headline PCE price index fell 1.1 percent, following a 0.5 percent decline in October. The core PCE price index was unchanged in both November and October.

Personal income Consensus Forecast for December 08: -0.4 percent

Range: -1.0 to 0.0 percent

Personal consumption expenditures Consensus Forecast for December 08: -0.9 percent

Range: -1.7 to -0.5 percent

Core PCE price index Consensus Forecast for December 08, m/m: 0.0 percent

Range: -0.1 to +0.1 percent

Core PCE price index Consensus Forecast for December 08, y/y: +1.9 percent

Range: +1.8 to +2.0 percent

The Institute for Supply Management's manufacturing index in December showed a worsening in the contraction of the manufacturing sector. The headline index dropped to 32.4 -- one of the very lowest readings in 60 years of data and down from 36.2 the month before.  Looking ahead, the picture is still gloomy.  The new orders index has contracted 13 consecutive months and is at the lowest level on record as is the index for orders backlogs.

ISM manufacturing index Consensus Forecast for January 09: 32.6

Range: 30.0 to 36.0

Construction spending declined 0.6 percent in November, after dropping 0.4 percent in October. Weakness in the latest month was led by a sharp 4.2 percent decrease in private residential outlays. But the other two major components actually rose. Private nonresidential spending rose 0.7 percent while public outlays increased 1.4 percent in November. On a year-on-year basis, overall construction outlays were down 3.3 percent in November.

Construction spending Consensus Forecast for December 08: -1.2 percent

Range: -5.0 to +2.0 percent

Tuesday

The pending home sales index fell 4.0 percent in November pointing to deepening declines for the housing sector. Year-on-year rates are also showing accelerating deterioration, at minus 5.3 percent in November compared with minus 1.0 percent in October. But last week, we saw a pickup in existing home sales.  Perhaps recent declines in mortgage rates are helping to offset the damage to home sales from higher unemployment.  On the other hand, the bump up in existing sales may have been due to strong seasonal factors in December.  Nonetheless, markets will be watching the pending sales index for any signs of improvement in the housing sector.

Pending home sales Consensus Forecast for December 08: 82.3

Range: 78.2 to 84.0

Wednesday

The composite index from the ISM non-manufacturing survey edged up a little over 3 points in December to 40.6.  But this level is still well below the breakeven point of 50, indicating that many more purchasers are reporting contracting conditions than expanding conditions.  Looking ahead, orders improved but still remained deep in negative territory, indicating continued contraction in overall activity.  The new orders index stood at 39.9 in December versus 35.4 the prior month, while backlogs came in at 42.5 versus 39.5 in November.

Composite index Consensus Forecast for January 09: 39.0

Range: 37.0 to 44.0

Thursday

Initial jobless claims rose 3,000 in the January 24 week to 588,000, indicating that the labor market is steadily worsening. Continuing claims showed special weakness for the January 17 week, the most recent data available, jumping 159,000 to a record 4.776 million.

Jobless Claims Consensus Forecast for 1/31/08: 583,000

Range: 480,000 to 620,000

Nonfarm productivity was weak in the third quarter, coming in at an annualized 1.3 percent.  Meanwhile, third quarter unit labor costs posted a 2.8 percent gain.  The worsening recession has led to a worsening in productivity and costs when compared to year-ago numbers. Year-on-year, productivity was up 2.1 percent in the third quarter while, unit labor costs came in at up 1.4 percent.

Nonfarm Productivity Consensus Forecast for initial Q4 08: +1.1 percent annual rate

Range: -1.0 to +4.0 percent annual rate

Unit Labor Costs Consensus Forecast for initial Q4 08: +2.9 percent annual rate

Range: -2.4 to +5.7 percent annual rate

Factory orders fell steeply in November, down 5.7 percent (originally 4.6) percent from a downwardly revised 6.0 percent decline in October. The decline was exaggerated by a price-related collapse in new orders for nondurable goods, specifically orders for energy products. Outside of nondurable goods, the decline in the month was a much less steep 3.7 percent (previously down 1.5 percent).  But more recently, durable goods orders declined another 2.6 percent in December, following a 3.7 percent decrease in November. With oil prices continuing to weaken, the nondurables component for December also is likely to be negative.  Overall, December should be another bleak month for factory orders.

Factory orders Consensus Forecast for December 08: -3.0 percent

Range: -6.8 to -0.8 percent

Friday

Nonfarm payroll employment for December was dismal as the number of jobs plummeted 524,000, following a drop of 584,000 in November. Payroll jobs contracted every month in 2008 for a cumulative loss of 2.6 million—the largest yearly drop since the end of World War II. Turning to wages, average hourly earnings rose 0.3 percent in December after gaining 0.4 percent in November. Wage gains were likely being kept a little high by the fact that average hourly earnings are not a fixed-weighted price index but one based on shifting components.  During recession, the lower wage earners are typically cut first due to the cyclical sensitivity of low-wage retail trade and due to workers with fewer years experience often being cut first. The civilian unemployment rate surged to 7.2 percent from 6.8 percent in November.  December’s number was the highest since 7.3 percent for January 1993.

Nonfarm payrolls Consensus Forecast for January 09: -524,000

Range: -750,000 to -450,000

Unemployment rate Consensus Forecast for January 09: 7.5 percent

Range: 7.2 to 7.6 percent

Average workweek Consensus Forecast for January 09: 33.3 hours

Range: 33.0 to 33.4 hours

Average hourly earnings Consensus Forecast for January 09: +0.2 percent

Range: 0.0 to +0.3 percent

Consumer credit has been taking a hit in recent months with the latest a record decline of $7.9 billion for November -- the third decline in four months. Revolving credit fell $2.8 billion, or 3.4 percent in the month, while nonrevolving credit fell $5.2 billion, or 3.9 percent.

Consumer credit Consensus Forecast for December 08: -$3.5 billion

Range: -$12.0 billion to +$1.5 billion

Econoday Senior Writer Mark Pender contributed to this article.