The week's economic reports

More dismal reports on the nation's housing market and strong third quarter economic growth highlighted the week's economic data. Stocks and bonds ended with the S&P 500 Index up 2.8 percent to 1,481, now up just 4.4 percent for the year, and the yield of the 10-year U.S. Treasury note fell 4 basis points to 3.97 percent.

Consumer Confidence: The mood of the consumer continues to darken as the Conference Board's measure of consumer confidence confirmed what was revealed in the Reuters/University of Michigan consumer sentiment index in recent weeks - the outlook of consumers is at lows not seen since immediately following Hurricane Katrina in 2005. Rising energy prices and falling home prices appear to be taking their toll.

Consumer confidence plunged from a downwardly revised 95.2 in October to 87.3 in November and, perhaps more importantly, the 12-month inflation outlook jumped from 5.1 percent to 5.7 percent. This is terrible news for the Federal Reserve who look increasingly likely to cut rates again in ten days - this is one of the two major gauges of "inflation expectations" that they are keen to keep in check (the other "inflation expectations gauge" is the difference in yield between inflation protected treasuries and fixed rate treasuries).

Durable Goods Orders: Orders for goods designed to last three years or more fell 0.4 percent in October following an upwardly revised drop of 1.4 percent in September. This is a volatile series due to the transportation category that is dominated by sometimes wild month-to-month swings due to aircraft orders, but, there is a clear slowdown in progress when looking at the year-over-year changes throughout 2007. From year-ago levels in the latest report, durable goods orders are now up only 1.0 percent after last month's year-over-year decline of 6.2 percent. Overall, this measure of future factory production is growing at a rate that, while still positive, lags reported inflation.

Existing Home Sales: The National Association of Realtors (NAR) reported lower sales of existing homes, dropping 1.2 percent in October to a seasonally adjusted annual rate of 4.97 million, the lowest monthly total since 1999 when this series began. More importantly, inventory continues to grow as both the numerator (inventory) and the denominator (sales rate) of the Months of Supply statistic continue to head in the wrong direction - the current 10.8 months of supply is more than double the normal rate of between four and five months.
Lower sales are now beginning to affect even the NAR's price statistics as the median home price fell to $207,800, a 5.1 percent decline on a year-over-year basis. At these levels of sales and inventory, there is ever-increasing downward pressure on home prices - it is likely that lower prices will be seen in the months ahead and well into 2008 even if there is no further deterioration in the sales and inventory data.

Gross Domestics Product: Third quarter real economic growth was revised upward a full percentage point from the "advance" estimate of 3.9 percent last month to a "preliminary" estimate of 4.9 percent. The third and "final" reading on Q3 GDP will be released in one month and the first look at Q4 GDP will be available at the end of January. In the chart below, growth appears to be surging recently, after a mild slowdown in late-2006 and early-2007, but that is anything but the case.

The upward revision to the very strong third quarter growth was primarily due to higher inventory levels, an indication of softening consumer demand ahead, and a continuation of the recent export surge resulting from a weaker U.S. dollar. Combine these factors with an energy price related statistical quirk that produced an annualized inflation rate of just 0.9 percent during July-August-September and you get what appears to be a healthy economy.

As indicated by the many downward projections for Q4 economic growth, some of which are close to zero, nearly all these factors are set to reverse in the final months of the year. Not only will consumer price inflation (used to convert "nominal" growth to "real" growth) be much higher due to soaring energy prices, but the impact on consumer spending, by far the most important component of economic growth, is at this time still a big unknown. Seasonal adjustments during a time of year when energy prices are generally declining and consumer spending is generally surging could result in some surprisingly weak fourth quarter data.

New Home Sales: There were a total of four housing reports last week and all of them were bad. In addition to continuing weakness in existing home sales reported by the National Association of Realtors (see above), the S&P Case-Shiller Home Price Index showed a year-over-year price decline of almost five percent and the OFHEO housing price index showed quarter-to-quarter price declines for the first time since the mid 1990s.

New home sales were similarly depressed even without factoring in cancellation rates that continue at extraordinarily high levels. The Commerce Department reported October new home sales at a seasonally adjusted annualized rate of 728,000, slightly above last month's revised total, but the more important elements in this report were the revisions of prior data - August sales were revised from 757,000 to 717,000 and September sales fell from 770,000 to 716,000. On a year-over-year basis sales are now down 24 percent, a number that would likely be even greater after next month's expected downward revision to this data.

The inventory of unsold new homes dropped marginally, from 9.0 months in September to 8.5 months in October, but there is little indication that this is the beginning of a trend toward more normal levels - builders continue to slash prices and offer larger incentives to an increasingly skittish public. Prices fell 8.9 percent from September to October and were down 13.2 percent on a year-over-year basis - once again, remember that these price drops do not factor in builder incentives. More and more analysts are already looking past 2008, figuring that housing won't start to improve until 2009.

Personal Income and Spending: Personal income and spending rose less than expected in October, both gaining only 0.2 percent following gains of 0.4 percent and 0.3 percent, respectively, in September. The personal savings rate fell from 0.7 percent in September to 0.5 percent in October and the PCE price index rose 0.3 percent, up 2.9 percent from year-ago levels.

Summary: While economic growth during the third quarter was surprisingly strong, unfortunately this is old news and reflects little of the post-credit crunch realities of recent months. Ignoring this one bright spot in last week's reports leaves a slew of negative news, the most important of which were the four dismal reports on the nation's housing market.

Add to this more evidence of plunging consumer confidence, a slowing manufacturing sector, along with a spike higher in initial jobless claims and it becomes clear why Federal Reserve members began changing their outlook on future interest rate policy last week, "opening the door" to another rate cut in December after having resisted that stance in prior weeks.

The Week Ahead: The week ahead will be highlighted by a much anticipated labor report on Friday. Also scheduled for release are the ISM manufacturing index on Monday, four reports - the ISM Non-Manufacturing index, ADP employment, productivity and costs, and pending home sales - on Wednesday, and both consumer sentiment and consumer credit on Friday.