Momentum Ride Puts Data in Back Seat Econoday Simply Economics 4/3/00 By Evelina M. Tainer, Chief Economist

High tech earnings and Abby spook markets
The NASDAQ composite index managed to end Friday on the positive side after being down much of the session. Nonetheless, investors were hit by a dramatic four-day rout in this index. Analysts worried that earnings might not be met and market guru Abby Joseph Cohen said that tech stocks should no longer be overweighted. In fact, she scaled back her stock allocation from 70 percent to 65 percent with the differential going to cash instruments.

The fall out in the high tech market seemed to help the old blue chip sector – until Friday anyway. During most of the week, the sharp differences between the high tech market and the old economy narrowed – as indicated by the chart above. The Dow remains 5 percent below year-end levels while the NASDAQ composite is still 12.4 percent above year-end. The S&P 500 and the Russell 2000 are also in black, although by a smaller margin than the high tech index.

Treasuries rally on non-economic events
Quarter-end window dressing tends to favor demand for Treasury securities. In addition, market players are now less enamored with the agency paper that was supposed to become an alternative benchmark to the Treasury market. Treasury officials indicated to Congress that the government should not continue extending its credit line. As a result, this would give agency paper a lower credit quality than it currently enjoys.

Treasuries saw a few other favorable factors this week as well. First, OPEC agreed to increase production levels. Since some of the OPEC countries were already "cheating" the price decline will be contained, but energy prices should nevertheless head lower going into the summer driving season. Second, the dramatic market correction in the NASDAQ this week sparked a flight to safety.

 

Markets at a Glance
Treasury Securities	12/31/99	Mar 23	Mar 31	Weekly Change
30-year Bond	6.48%	6.00%	5.83%	- 17 BP
10-year Note	6.43%	6.20%	6.01%	- 19 BP
5-year Note	6.34%	6.51%	6.32%	- 19 BP
2-year Note;	6.24%	6.62%	6.48%	- 14 BP
Stock Prices
DJIA	11497*	11113*	10922*	- 1.7 %
S&P 500	1469*	1528*	1499*	- 1.9 %
NASDAQ Composite	4069*	4964*	4573*	- 7.9 %
Russell 2000	505*	574*	539*	- 6.1 %
Exchange Rates
Euro/$	1.0008	0.9774	0.9564	- 2.1 %
Yen/$	102.40	107.05	102.71	- 4.1 %
Commodity Prices
Crude Oil ($/barrel)	$25.60	$28.0	$26.80	- 4.5 %
Gold ($/ounce)	$289.60	$285.20	$281.60	- 1.3 %
(BP = basis points; stock price indices are rounded)

Factory orders moderating but still on the upswing
Factory orders fell 0.8 percent in February after a 1.2 percent drop in the previous month. Consequently, total new orders are up at a slower rate in the first two months of the first quarter relative to the previous two quarters of 1999. Nondefense capital goods orders are posting moderate gains – suggesting a slowdown in capital spending going forward. Information technology is still the place to be – new orders were up at an 18.9 percent rate in the first two months of 2000 relative to the previous quarter. While new orders have generally moderated in the past two quarters, the three straight quarterly gains in these series represent a strong manufacturing sector. Note that new orders had declined in two of the previous four quarters.

This is not the only strong showing among manufacturing indicators. The Chicago purchasing managers index edged higher in March to 57.4 with gains in production, order backlogs and inventories. New orders were slightly weaker in this report, but still at high levels representing continued expansion in manufacturing. The Chicago purchasing managers’ report has a wide following because the distribution of industries in this region is comparable to the nation's. The report could foreshadow an upward drift in the NAPM for March as well. (The national index will be reported on Monday, April 3.)

The bottom-line on manufacturing? The January and February declines in factory orders give a misleading picture of the manufacturing sector. The underlying trajectory points to healthy growth in capital spending in the first half of 2000. This means that industrial production will show some acceleration as well. Typically, increased investment spending is viewed as less inflationary as spending on consumption goods because capital equipment tends to enhance productivity. Nonetheless, the Fed could become concerned that the improved production outlook will generate demand for factory employment that can’t be satisfied in these tight labor markets.

Consumer euphoria everlasting despite dip in confidence surveys
Both major consumer sentiment surveys dipped slightly in March, yet there is no doubt that consumers are still feeling pretty good about economic conditions. In both cases, the drop in confidence was due to expectations about future conditions. The drop could partly reflect the greater volatility in the stock markets and the surge in oil prices, which of course is felt at the gas pump. Though gas prices are likely to turn around now that OPEC has agreed to increase production, the stock market is another question entirely!

Personal income rose 0.4 percent in February after a stronger 0.7 percent gain in January. Wages and salaries were hampered in February by the sluggish payroll performance. In turn, January income was boosted by special factors such as cost-of-living increases for government workers and social security recipients. At the same time, personal consumption expenditures jumped 1 percent in February after a slower, albeit still solid 0.6 percent hike in January. A surge in auto and light truck sales boosted February expenditures. Spending for nondurables and services was less robust for the month. As indicated in the chart below, the yearly rise in real income and spending is moderating to a small degree. Nevertheless, the gap between the two series remains extraordinarily wide. As a result, the personal savings rate continues to tumble. It stood at 0.8 percent in February. Personal savings are often sluggish in times of prosperity when consumers aren’t worried about their jobs and meeting loan payments.

It is possible that consumer spending may soon moderate – at least for durable goods purchases. The chart below shows the sharp drop-off in total home sales since their peak during the summer months last year. The February gain in home sales is modest relative to the January decline. Mortgage rates appear to have settled around 8 ¼ percent, but are clearly higher than they were a year ago. Eventually, softer housing demand will curtail spending on furniture and appliances.

The bottom-line on the consumer sector? Data for February and March still reflect a pretty happy consumer with an open pocketbook. The moderation in the housing market should dampen spending for furniture and appliances in the next several months. If consumers become less confident about the stock market – even only because of the greater volatility rather than any serious market correction – they may also be less inclined to make large purchases. In any case, the signs aren’t compelling enough yet to prevent the Fed from raising the federal funds rate target at the next FOMC meeting in mid-May.

Bits and pieces
The Conference Board’s help wanted index edged down to 88 in February. The index has fluctuated somewhat these past couple of years, but on the whole, it has remained at these high levels since 1995. New jobless claims are reaching historical lows. These two series point to the same evidence viewed in the employment situation – labor markets are tight. This will only add fuel to the Fed’s fire.

The Commerce Department reported its final estimate for fourth quarter GDP this past week. It appears we need to find new superlatives to describe economic conditions: Roaring, Skyrocketing may not be good enough … Real GDP soared at a 7.3 percent rate in the fourth quarter. The revision showed more export growth and less inventory building for the October – December period. This old news had virtually no impact on the financial markets – and is unlikely to sway the opinions of Fed officials one way or the other. Corporate profits were also reported – showing accelerated growth from the two middle quarters of the year.

THE BOTTOM LINE
Financial market participants were confronted with a good amount of economic indicators this past week although the data could not be described as market moving. Indeed, the market gyrations seemed to come from other sources.

The set of economic news this week is not likely to cause Fed officials to change their views about robust economic activity, tight labor markets and the potential for inflationary pressures. The housing data was a bit heartening in that a clear downward trend seems to have emerged. But the Fed will need to see this trend continue into the spring and summer. Consumer spending hasn’t moderated sufficiently to reassure Fed officials that real GDP growth is now growing at the long-term sustainable pace of 3 to 3 ½ percent. In fact, manufacturing activity is picking up steam these days to offset any hints of slowdown elsewhere.

Market players are pretty much convinced that the Fed will raise rates at least one more time (by 25 basis points) and probably two more times. Some market pundits are toying with the idea that the Fed will raise rates by 50 basis points. (After all, it was a discussion point at the February FOMC meeting.)

Fed officials may not like market volatility, but they may be encouraged that a market correction might dampen consumer euphoria and make investors realize once again that stock market investing is indeed a risky proposition.

Looking Ahead: Week of April 3 to April 7
Market News International compiles this market consensus which surveys about 20 economists each week.

Monday
Market players expect construction spending to decrease 0.5 percent in February after posting stronger gains in the previous couple of months. This would be a modest reversal to the previous two-month’s cumulative gain of 4.8 percent.

The NAPM survey should inch higher to 57.0 in March, following the pattern set by the PMAC survey on Friday. This would be little changed from the February level of 56.9. Market players will also focus on the prices paid component, which stood at 74.1 in February. Some forecasters brave enough to make a forecast are looking for an increase to 75 in March.

Tuesday
The market consensus is looking for the Conference Board’s index of leading indicators to decrease 0.2 percent in February, nearly reversing the January rise. Despite the expected drop, the index is not pointing to an economic downturn.

Motor vehicle sales are predicted to drop sharply in March from the 19 million unit rate posted in February. Autos are expected to run at a 7.2 million-unit rate and light truck sales should run at a 7.8 million-unit rate.

Thursday
Market participants are expecting new jobless claims to rise 4,000 in the week ended April 1 from last week's 266,000 level.

Friday
Economists are centering their forecasts around a 370,000 gain in nonfarm payroll employment for the month of March – with a range of 175,000 to 480,000. This clearly excludes the Wall Street economist who spooked markets last week with his forecast of a 625,000 surge. The market consensus is looking for a 4 percent unemployment rate. Average hourly earnings are expected to rise 0.3 percent while the average workweek should inch up to 34.6 hours from a level of 34.5 last month.

Economists expect consumer credit will expand a mere $10 billion in February, down from the $17 billion gain recorded in January. Given the surge in motor vehicle sales during the month, market players may be surprised on the upside.