The week's economic reports

A disappointing labor report and a sharp decline in the ISM manufacturing index highlighted the week's economic data. Stocks and bonds ended with the S&P 500 Index down a whopping 4.5 percent to 1,412 and the yield of the 10-year U.S. Treasury note fell 22 basis points to 3.85 percent.
ISM Manufacturing Index: The nation's broadest measure of manufacturing activity registered its lowest reading in almost five years, plunging from 50.8 in November to 47.7 in December. Recall that values above 50 indicate expansion and below 50 indicate contraction.

The overall decline was driven primarily by a sharp drop in new orders, from 52.6 in November to 45.7 in December, which now stand at their lowest level since 2003.

New export orders disappointed as well, falling from 58.5 to 52.5, and remain about the only bright spot in this sector, but one that succumbed to the same slowdown as seen elsewhere in closing out the year.

Declining orders resulted in weaker production, which fell from 51.9 to 47.3. The only category well above the expansion/contraction line was prices paid, which rose from 67.0 to 68.0, further evidence of the higher cost of raw materials that continue to be felt in manufacturing. In all, six of the nine categories indicated contraction.
This decline has an entirely different feel than the one seen late in 2006 and early in 2007 which resulted in two readings that fell just below the 50 mark. Additional data in the months ahead will confirm whether this will be a protracted slowdown or if some sort of a recovery will be staged as was seen last year.

Most analysts view the 45 level and below as "recession territory". As seen in the chart above, in late-2000, three consecutive sub-50 readings contributed to the first interest rate cut very early in 2001, then additional sub-45 readings helped in convincing the Federal Reserve to cut rates throughout the rest of the year.

Employment Report: Job growth came in well below expectations as the Bureau of Labor Statistics reported a seasonally adjusted nonfarm payrolls increase of just 18,000 during December, the smallest monthly gain since 2003, and the unemployment rate rose from 4.7 to 5.0 percent.

As has been the case for much of the last year, employment declined in both construction and manufacturing, down 49,000 and 31,000, respectively, and retail sales positions were cut by 24,000. Gains were seen in the usual places with increases of 44,000 in education and health services and 43,000 in professional and business services.

State and local governments were largely responsible for an overall gain of 31,000 jobs in the public sector. Excluding these new positions, private sector payrolls fell by a total of 13,000, the first such decline since June of 2003.
Revisions to October and November totaled +10,000, the October increase being revised down from 170,000 to 159,000 and the November gain rising from 94,000 to 115,000.

As shown in the chart, there has been an unmistakable downward trend since early in 2006 when the bloom first came off of the housing boom. For the year just concluded, job gains totaled just 1.0 percent following gains of 2.0 percent in 2005 and 1.6 percent in 2006.

Average hourly earnings held steady with a 0.4 percent gain in December, equaling the November increase, and the average workweek remained at 33.8 hours.

The household survey surprised most analysts as the unemployment rate jumped three points from a downwardly revised 4.7 percent in November to an even 5.0 percent in December. Many had been expecting a more gradual increase in unemployment early in 2008, but this increase is consistent with generally higher new claims for unemployment insurance in recent months.

Summary: The two reports on manufacturing and employment were clear signs that there may be trouble ahead for the U.S. economy in 2008. Both of these came in well below analysts' expectations and each of these reports will be closely scrutinized in the months ahead to determine if the December data was the beginning of an accelerated decline or one-off events.

Complicating the picture for the labor market, with next month's January employment data, benchmark revisions for the prior year will be released and it will be revealed just how badly the birth-death model overestimated job creation in the important construction and financial activity sectors.

Elsewhere last week, auto sales were weak and Toyota took over the number two spot from Ford in U.S. auto sales. Initial claims for unemployment insurance were below the levels of recent weeks, however, a number of factors involving adjustments for the holidays at year-end made this small decline meaningless. The trend in jobless claims will be watched closely in the month ahead to see if the moving average rises further before the next labor report in early February.

The lone bright spot for the week was the modest gain in the ISM non-manufacturing index.

The Week Ahead: The week ahead will be highlighted by reports on pending home sales on Tuesday and the U.S. trade deficit on Friday. Also scheduled for release are reports on consumer credit on Tuesday, and import/export prices on Friday.