Saturday, May 31, 2008
Falling home prices, plunging consumer confidence, and a modest upward revision to first quarter real economic growth highlighted the week's economic reports. Stocks and bonds ended with the S&P 500 Index up 1.8 percent to 1,400, now down 4.6 percent for the year, and the yield of the 10-year U.S. Treasury note rose 21 basis points to 4.06 percent.
New Home Sales: Sales of new homes rose modestly in April, up 3.3 percent from a downwardly revised annualized rate of 509,000 in March to 526,000. From the unrevised rate in March, sales volume was flat and on a year-over-year basis, sales are down 42 percent, the steepest annual decline since the early 1980s.
Though it is always difficult to discern the true sales price after factoring in builder incentives, the reported median sales price rose 9.1 percent for the month, posting a surprising increase of 1.5 percent from year ago levels.
The inventory of unsold homes remains quite high, down slightly from 11.1 months in March to 10.6 months in April and, as noted on many occasions before, this sales rate/inventory combination is the most important metric to be considered regarding the future direction of home prices. Until inventory comes down, there will continue to be pressure on prices.
The S&P Case-Shiller Home Price Index was released last week showing even bigger declines in property values (see Home prices: How low can you go?). The 20-city index dropped 2.6 percent from February to March, now down a whopping 14.4 percent from year ago levels. Six former housing bubble hot-spots showed year-over-year price declines of more than 20 percent - Las Vegas, Miami, Phoenix, Los Angeles, San Diego, and San Francisco - with only Charlotte, North Carolina posting an annual gain of a modest 0.8 percent.
While home sales may form a bottom in 2008, there is a near unanimous consensus that home prices will continue to decline throughout the year and probably well into 2009, perhaps beyond.
Durable Goods Orders: Orders for durable goods fell 0.5 percent in April after a decline of 0.3 percent in March. Excluding the always volatile transportation sector, new orders rose 2.5 percent paced by a 28 percent increase in electrical equipment. Within the transportation group, new orders fell 24 percent for nondefense aircraft and 3.3 percent for autos.
From year-ago levels, durable goods orders are down 3.4 percent - a clear indication of continuing weakness in manufacturing.
Gross Domestic Product: It appears as though government reported "inflation adjusted" economic growth will remain positive during the first quarter of 2008 as the "preliminary" estimate of real GDP (the second of three estimates for Q1) came in at an annualized rate of 0.9 percent.
This is an improvement on the 0.6 percent rate reported a month ago, and on a year-over-year basis, real GDP now stands at 2.5 percent. The "final" estimate will be released at the end of June and then the "advance" estimate of economic activity in the second quarter will be reported at the end of July.
The improvement in the headline number reflects a narrower trade deficit and higher levels of inventory than first estimated. As has been seen in the monthly reports on international trade, lower imports (despite higher oil prices) have been the driving force for the trade gap narrowing.
The first quarter GDP price index was unchanged at an annualized rate of 2.6 percent - this is the dubious "GDP deflator" responsible for transforming "nominal" growth to "real" growth through a rather complex calculation. PCE inflation came in at 3.5 percent, which is mostly in line with the Consumer Price Index over the same period, though both of these measures of "inflation" are increasingly suspect as well.
Current estimates for second quarter growth are mostly in positive territory, largely a result of an improved trade deficit and steady government spending. Masked somewhat by rising gasoline prices, growth in consumer spending is declining but it remains positive - this holds the key to future economic activity in the U.S. as many are now expecting the consumer retrenchment to gain pace.
Consumer Confidence/Sentiment: Both the Conference Board's consumer confidence survey and the Reuters/University of Michigan consumer sentiment survey continue to indicate major distress amongst consumers, the former falling to a 16-year low and the latter visiting levels last seen in 1980.
In its latest reading, consumer confidence fell five points from 62.3 in April to 57.2 in May and one-year inflation expectations rose to a shocking 7.7 percent. Those saying that jobs are plentiful fell to 16.3 percent while those saying they are hard to get rose to 28.0 percent.
The consumer sentiment survey confirmed a mid-month reading of two weeks ago, falling almost three points from 62.6 in April to 59.8 in May with a similarly elevated outlook for inflation over the next year of 5.2 percent.
Note that the two readings on "inflation expectations" contained in these two surveys have always been off by a couple percentage points or more, but they have tracked each other reasonably well over time. Along with the difference in yields between U.S. Treasuries and "inflation-protected" Treasuries (TIPS), these survey responses are a major source of the Federal Reserve's "inflation expectations" metric, a key consideration when they deliberate on monetary policy.
For many years these measures were in the two to four percent range with only a temporary move upward after the 2005 hurricanes pushed energy prices sky high. The recent move, however, driven by both energy and food, has been much more pronounced and sustained. The Fed is understandably concerned about these statistics as "anchoring" inflation expectations has been an integral part of monetary policy for some time. It is significant that consumer "inflation expectations" are now two to four percentage points higher than the Fed's inflation estimates.
Summary: Due to the size and nature of the upward revision to GDP - less imports and rising inventory - it's hard to get too excited about economic growth in the first quarter particularly when considering how big a role the inflation statistics play in determining whether the final number is positive or negative. Previously, most analysts were projecting at least one quarter of negative real growth in the first half of the year, now it appears that there will be none - annualized growth of between 0 and 1 percent is now the consensus for the second quarter.
Meanwhile, home prices continue to plunge along with consumer confidence. As the mood of the consumer is highly correlated with gasoline prices, unless home prices head back up and prices at the pump head back down (both of which seem very unlikely, at least in the near-term), there will likely be continuing pressure on the consumer sector that will show up during the second half of the year, a time when many economists are forecasting a rebound.
As the election season heats up, it will be interesting to see how the role the consumer is framed in the expected debate over the health and the future of the U.S. economy.
The Week Ahead: The coming week will be highlighted by the ISM manufacturing report on Monday and the labor report on Friday. Also scheduled for release are reports on construction spending on Monday, three reports on Wednesday - ADP employment, productivity/costs, and ISM nonmanufacturing, ending the week with a report on consumer credit on Friday.