Saturday, June 14, 2008
Surprisingly strong retail sales and a surge in consumer prices highlighted the week's economic reports. Stocks and bonds ended with the S&P 500 Index down less than one percent to 1,360, now down 7.4 percent for the year, and the yield of the 10-year U.S. Treasury note rose 30 basis points to 4.26 percent.
Pending Home Sales: The National Association of Realtors' index of pending home sales jumped 6.3 percent from March to April improving the year-over-year change from minus 20 percent to minus 13 percent. While some pundits were heralding the revival of the nation's housing market, only a superficial review of the data would lead one to that conclusion.
First, these are pending sales which means that a sales contract has been negotiated and agreed to but has no guarantee of closing. While there are no statistics to support this, anecdotal reports are that cancellations due to tighter lending standards are now approaching historical highs. Secondly, in many parts of the country, foreclosure sales and short sales now contribute an outsized portion of overall sales, all of which are occurring at greatly reduced prices. Not far from here in Sacramento, foreclosures have accounted for between a half and two-thirds of all monthly real estate sales.
Lastly, it should not be too surprising to see overall sales bottom out sometime this year. Current sales are at historically low levels (and they look even worse when adjusted for population growth) and there is some minimum number of houses that are bought regardless of all other factors. While the bottom in sales may not be far off (and this will surely be good news for those in the business of selling real estate), what is more important for the economy as a whole are home prices and home prices are driven by the relationship between sales volume and the supply of unsold homes. With inventory now standing at more than double the historical average near ten months of supply and with more bank owned properties coming onto the market, this will exert downward pressure on home prices for some time to come.
International Trade: Largely due to recent the run-up in oil prices, the trade gap between the U.S. and the rest of the world widened from a revised $56.5 billion in March to $60.9 billion in April. Exports rose 3.3 percent, but imports rose 4.5 percent. The oil trade deficit rose from $30.2 billion to $34.5 billion, a new all-time high, as the average price paid for a barrel of oil jumped from $89.85 in March to $96.81 in April. With oil prices now substantially higher, look for an even bigger oil import total in the international trade report for May.
Retail Sales: Both retailers and shoppers benefited from the nearly $50 billion of rebate money that was sent out to American consumers last month.
Surprising even the most optimistic analysts, retail sales surged by 1.0 percent in May with large upward revisions applied to both the March and April data. Sales in March were revised from a gain of 0.2 percent to 0.5 percent and April sales improved from a decline of 0.2 percent to a gain of 0.4 percent.
As in months past, gasoline station sales were the fastest rising category (up 2.6 percent) but other gains were broad based. Sales at building material and garden equipment stores (e.g. Home Depot and Lowes) rose a whopping 2.4 percent, though, this comes after months of declines.
From year-ago levels overall sales are now up 2.5 percent, a figure that is not adjusted for inflation and therefore, in real terms, is still negative.
As a rough measure of the impact of the stimulus checks, consider that the overall increase of 1.0 percent in retails sales during May amounts to about $4 billion (from an April level of $381.6 billion to March's $385.5 billion). In recent surveys, more than two-thirds of recipients said they would either pay down bills (48%) or save the money (25%) while discretionary spending (14%) and other (13%) lagged far behind. Based on this data, the $48 billion sent last month could account for the entire increase in spending.
Importantly, the upward revisions for March and April were likely not affected by the rebate program since government money did not start arriving until the end of April. With about an equal amount of money being sent during the month of June, the real test of the health of the American consumer should come with the July retail sales data.
Consumer Prices: As expected, consumer prices rose sharply in May driven higher by soaring energy costs. The overall rate of inflation rose 0.6 percent pushing the year-over-year rate up from 3.9 in April to 4.2 percent in May.
The core rate of inflation (excluding food and energy) rose 0.2 percent for the month leaving the annual rate unchanged at 2.3 percent.
Energy prices surged 4.4 percent in May after coming in flat for April, bringing the year-over-year increase in energy prices to 17.4 percent. Heating oil rose 7.9 percent for the month and is 50.9 percent higher than last year at this time while gasoline rose 5.7 percent in May and is up 20.8 percent on an annual basis.
Food prices rose 0.3 percent for the month and are now up 5.1 percent from year-ago levels.
The nefarious owners' equivalent rent rose only 0.1 percent. Contributing about 23 percent of the overall inflation total, this helped to keep the headline figure from appearing any worse than it already did.
There is a bit more on this topic in Friday's blog post Inflation (statistics) remain contained including a closer look at the food category of the Consumer Price Index showing some surprising differences between food categories.
Consumer Sentiment: The Reuters/University of Michigan consumer sentiment survey plunged to a 28-year low in the initial reading for the month of June (this survey data is published twice per month - at mid-month and at month end).
After falling in May to 59.8, the index sank to 56.7 in June as consumers continue to grapple with rising energy prices, falling home prices, a falling stock market, and a weakening labor market.
Rising prices remain a tremendous concern to survey respondents with one-year inflation expectations unchanged from late-May at 5.1 percent and five-year expectations now at 3.4 percent.
Historically, there is not the relationship between consumer sentiment and consumer spending that you might think. The American consumer has routinely responded negatively in surveys such as this one and then gone out and continued to spend freely. It remains to be seen how consumer spending will fare after this dramatic decline in consumer sentiment and after all the rebate money has been distributed.
Summary: Once again, there was reason for some to cheer this week as pending home sales and retail sales both rose but, as explained above, there is little reason to think that the U.S. economy has now turned a corner based on this new data. There are far too many negatives at the moment and, in my view, recent upbeat outlooks for the second half of the year will prove to be off the mark.
Nonetheless, after the strong retail sales report it appears that the U.S. economy will post positive real economic growth for the entire first half of the year. Draw your own conclusions about "real" real economic growth based on the dubious nature of the government's inflation data that, for purposes of calculating real GDP, comes in at about three percent per year.
Last week, forecasters at Morgan Stanley reversed their call for the economy to contract during the second quarter revising their growth estimate from -0.2 percent to +0.5 percent. The firm also indicated that it expects first quarter GDP growth to be revised from 0.9 percent to 1.2 percent in its final estimate at the end of the month.
The Week Ahead: The coming week will be highlighted by reports on housing starts and producer prices on Tuesday. Also scheduled for release are reports on international capital flows, New York area manufacturing, and the housing market index on Monday, producer prices and industrial production on Tuesday, and leading economic indicators and Philadelphia area manufacturing on Thursday.