November PPI friendly for markets

If the weekly change is positive, it must be the NASDAQ
Equity prices gained on Friday, but because of declines earlier in the week, the S&P 500 and the Dow Jones Industrials average both posted declines for the week. Both are near their all-time highs and performing well on a year-over-year basis. Even the Russell 2000 has improved recently.

But the NASDAQ composite is at stratospheric levels. Most analysts are expected near term corrections in this market. Yet, many talking heads this past couple of weeks have indicated that the soaring market is fueled by an early "January effect." With just a couple of weeks to go before yearend, the NASDAQ has jumped 65 percent this year! It makes the rest of the market indices look paltry. Yet, given the double-digit gains of the past few years, even the "moderate" increases in the Dow and the S&P should be considered good.

Treasury yields dip
It was a light week for economic news and sentiment was relatively neutral this past week. The PPI figures were friendly for the markets and this helped to fuel a mini-rally in the bond market. Yields are down from a week ago across the spectrum of maturities.

Energy prices rise but core PPI unchanged
The producer price index rose 0.2 percent in November, in line with expectations. After a brief dip last month, energy prices jumped again in November. Food prices inched only modestly higher for the month. Excluding food and energy, the PPI (also known as the "core") was unchanged in November. As a result, the yearly change remains below 2 percent. However, the total PPI is now 3.1 percent above year ago levels -- and as high as reported in mid-1996.

Many financial market participants also look to the PPI for crude materials and intermediate goods to see if inflation is accelerating in the pipeline. Actually, the intermediate goods index is also up 3 percent from a year ago; and excluding food and energy products, it is up 1.5 percent. Crude materials are up more dramatically. The total index is up 16 percent from last November. Even excluding food and energy products, the index is 9.7 higher than a year ago. It appears that producers are taking the higher costs in lower profit margins, rather than raise prices in this competitive environment.

The Labor Department also reported import and export prices earlier this week. Export prices were up only modestly, but import prices rose more dramatically because of higher energy costs. Note the sharp climb in the yearly import price index in the chart below. Even export prices are over the zero mark.

The bottom-line on inflation? Energy prices are clearly boosting all price indices. Yet, even after removing this volatile component, prices are somewhat higher than a year ago. Based on the sharp distinction between the PPI for finished goods and the PPI for crude materials, it does seem that producers are very leery about raising prices for their customers. Inflation may be a factor that causes the Fed to raise rates early next year, but this week's set of data aren't foreboding.

Productivity gains robust
Nonfarm productivity was revised higher in the third quarter to expand at a 4.9 percent rate. This exceeds the pace recorded in the first half of the year and was the fastest pace since the fourth quarter of 1992. Moreover, nonfarm productivity grew 3.1 percent versus a year ago, also faster than the previous two quarters and in line among strong gains in the past few years.

Unit labor costs decreased at a 0.2 percent rate in the third quarter, a slight downward revision from the initial estimate. On a year-over-year basis, unit labor costs were up 1.5 percent. This is also a reduction over the past several quarters.

The bottom-line on productivity? Productivity has increased at a healthy rate in this expansion. Indeed, the gains we have experienced in the past couple of years are larger than usual for this mature stage of the business cycle. Productivity gains have allowed accelerated wage gains without the problem of inflationary pressures.

No one disputes that the productivity gains of the past few years have exceeded expectations and have helped contain inflationary pressures. The question now -- debate really -- is whether productivity growth can continue at the pace we have seen. Most policy-makers, including Fed chairman Alan Greenspan aren't so sure that current productivity gains are sustainable. If productivity begins to grow more slowly in coming months, it will mean that wage hikes could develop into consumer price inflation.

It is important to realize, though, that the debate is ongoing. These are uncharted waters for policymakers -- and economic forecasters -- to some degree.

Consumer credit growth moderates
Consumer installment credit expanded only $4.2 billion in October after a downward revised gain of $3.5 billion in September. Despite the lower rate of consumer credit usage, the debt-to-income ratio still peaked at 20.5 in September and then dipped to 20.3 in October. These are historical highs. It has long been established that consumers feel more comfortable with credit cards -- and in fact use credit cards for convenience and even pay off their balances in full each month. But the combination of high credit usage with a plunging saving rate is not sustainable. If income growth were to suddenly moderate, or the stock market to realize a correction, consumers wouldn't have much of a cushion to fall back on.

The bottom-line on credit? Consumer spending is fueled by income, stock and housing appreciation. This means that consumers are borrowing more and saving less. In a robust economic environment, that isn't necessarily a problem. But should some factor from out of the blue cause income to moderate or the market to drop sharply, consumers won't have much of a rainy day fund.

THE BOTTOM LINE
It was a light week for economic news. Certainly it was not the kind of news that generally moves markets -- or creates new ideas among policy-makers at the Federal Reserve. The inflation news was expected. Energy prices continue to be the major culprit behind increases. Producers are not raising prices for customers yet, which means that profit margins may be taking it on the chin.

The likelihood of a change in interest rates at the December meeting is virtually nil. Yet, Fed officials may debate the benefits of re-instituting a bias towards tightening. When they raised rates last month, they had shifted policy back to neutral. A tightening bias would indicate to financial market players that Fed officials were on serious alert and monitoring closely the booming economy (which is growing faster than the potential no matter who measures potential!)

Looking Ahead: Week of December 13 to December 17
We use the Market News Service survey of forecasts to describe the market consensus.

Tuesday
Market participants expect the consumer price index will rise 0.2 percent in November, matching the October gain. Excluding the volatile food and energy component, the CPI is expected to rise 0.2 percent as well. This would also match the October gain.

Economists are predicting that retail sales will increase 0.5 percent in November - better than the October pace which reflected no growth for the month. Excluding the auto group, retail sales could rise 0.4 percent, just a tad less than the previous month's gain of 0.5 percent. Remember that retail inflation is virtually nonexistent. This means that current dollar gains are nearly the same as real (inflation-adjusted) increases.

Wednesday
Business inventories are expected to increase 0.4 percent in October, the same as September's rise. Inventory building will probably help to boost GDP growth in the fourth quarter, but are likely to run down in the first half of 2000 and dampen growth early next year.

The market consensus calls for a 0.2 percent gain in the index of industrial production in November. This is based on the mediocre showing in factory payrolls and the average workweek. As a result, the capacity utilization rate could dip to 80.6 percent from 80.7 percent in October.

Thursday
Market participants are expecting new jobless claims to decrease 3,000 in the week ended December 11 from last week's 293,000. Claims remain range-bound.

Economists predict that the international trade deficit on goods and services will remain nearly unchanged in October at $24.2 billion. This reflects a modest increase in exports that is outpaced by a rise in imports.

Market players are looking for a slight downtick in the Philadelphia Fed's business outlook survey to 15 in December from 15.8 in the previous month. This is the first piece of information on December activity and may be monitored closely.

Friday
Housing starts are expected to increase modestly in November to a 1.65 million unit rate. Housing activity remains at high levels but has fallen off from the peak levels posted earlier this year. To some degree this may reflect supply shortages in various parts of the country, rather than a drop in demand. Building permits are predicted to remain nearly unchanged in November at a 1.60 million unit rate.