What is the state of consumer affairs these days?
Personal income fell 0.1 percent in November for the third straight month. This was mainly due to stagnation in the wages and salaries component. It is hard to see wages & salaries rise when employment is declining. Transfer payments, dividends and rental income seem to be keeping personal income afloat. Disposable income, which excludes taxes, was unchanged in November after two sharp declines in the two previous months. But tax rebates have skewed the report, as they appear in July and August but not September and October.

Personal consumption expenditures fell 0.7 percent (although only 0.6 percent after adjusting for inflation). A sharp drop in energy prices led to a decline in nondurable spending in nominal terms, but not in real terms. We commented on this phenomenon last week when retail sales were released. Granted, it doesn't make the consumption data robust, but the weakness is not as severe. In fact, real personal consumption expenditures are now up at a 4.7 percent rate (for October and November) relative to the third quarter, boosted by a surge in motor vehicle sales. Even if December spending records a small drop, the quarterly figures will look pretty decent.

The personal savings rate was back up to 0.9 percent in November after plunging to 0.2 percent in October from a recent high of 4.7 percent in September. What a roller coaster ride! The fact is that July and August income, but not spending, was boosted by tax rebate checks. September consumption expenditures fell more rapidly than disposable income, which allowed the personal savings rate to surge for a couple of months. Then the introduction of incentives induced consumers to splurge on motor vehicles. The purchase of large ticket items shows up for the entire sales price, not just the down payment, making it appear that consumers are withdrawing all their savings, when they are not. It may take a couple more months to get a truer reading on the savings rate. In any case, consumers tend to save more during economic downturns because they feel insecure about their job stability.

As it turns out, consumers may be starting to feel better about economic conditions. The University of Michigan's consumer sentiment index increased to 88.8 in December from 83.9 in November. Clearly, the chart shows that current levels are well below those of a year ago. Nevertheless, it does feel like consumers are starting to climb out of the gloom period established on September 11. Conventional wisdom says that retail sales move in tandem with consumer sentiment. We agree with that statement - to a degree. Over long stretches, retail sales do parallel sentiment, but on a month-to-month basis, that is not entirely true. Don't look for a 5.8 percent gain in December retail sales (the percentage difference between the levels of consumer sentiment between November and December.)

Housing market soars
Housing starts jumped 8.2 percent in November to a 1.645 million-unit rate, more than reversing the previous month's drop of 4 percent. The November spurt put starts 5.5 percent above year ago levels. The good news is that starts of single-family homes increased 3.2 percent to a 1.261 million-unit rate, but this just about offset the previous month's drop. Yet single-family construction is up 4.3 percent from last November. The bulk of the gain was concentrated in the multi-family sector, which posted a 28.4 percent jump. This shouldn't be discounted because it will add to residential investment. Nevertheless, multi-family starts tend to be more volatile from one month to the next and can't be counted on to maintain a trend. All regions but the South posted strong gains in November. All regions but the West are up from year ago levels.

Notice the little uptick in the mortgage rate in November. On average, mortgage rates were up only 4 basis points from the previous month to 6.66 percent. However, don't expect such good news for December. The three weeks of December are already averaging a 7.03 percent rate, up 37 basis points. This is ironic in light of the 475 basis points reduction in the Fed's funds rate target. Typically, Federal Reserve easing helps spur economic activity during a recession, first through the housing market because it is so sensitive to interest rate changes. The Fed eased far more than is evident by the modest 200 basis point drop in mortgage rates from a mid-2000 peak to a low point a couple of months ago. Furthermore, it is likely that rates will inch up rather than decline in the next couple of months based on the sharp upward movement in the U.S. Treasury market. As a result, housing may not be the impetus behind economic recovery in 2002. This will dampen the strength of the recovery.

Will manufacturing come back to life?
The Philadelphia Fed's business outlook survey recorded a level of -5.5 in December, less negative than the levels of the two previous months (-20.2 in November and -27.4 in October). Any level below zero still means that the manufacturing sector is contracting. Nevertheless, this is the sharpest improvement we've seen in the past several months and possibly the beginning of a favorable trend. This index only covers the Philadelphia Federal Reserve district. However, it does a good job of predicting changes in the index of industrial production. Perhaps the December production data will show a smaller decline as well.

International Trade
Don't expect much of the production growth to come from the export sector. The international trade deficit on goods and services widened sharply in October to $29.4 billion after recording a shortfall of $19.0 billion in September. The trade gap was affected by re-insurance payments in September in the wake of the September 11th tragedy. The flow of funds from foreigners to the U.S. was not even registered in the Commerce Department's third quarter GDP figures. Thus, September's improvement can be ignored. October not only returned to the old ways but seems to show a larger deficit than the previous months. It is worth noting, however, that October's surge in imports may be due to the fact that ships weren't allowed to dock at ports in September. We will need several more months of data to see what is happening in the net export sector before we can determine a trend.

Old news
The Commerce Department reported its second revision to third quarter real GDP. The downward revision in real GDP to -1.3 percent was not far off from the previous estimate of -1.1 percent. Personal consumption expenditures were revised down slightly, but business fixed investment was revised up (showing a smaller decline than originally reported). Net exports were also revised lower with a sharper decline in exports. On the whole, the revisions don't change the economic landscape nor are they large enough to change the outlook for the fourth quarter or the first half of 2002. It was a soggy quarter.