The week's economic reports

Falling home prices and plunging consumer confidence, now at multi-decade lows, highlighted the week's economic reports. Stocks and bonds ended with the S&P 500 Index down 3.0 percent to 1,279 (for a year-to-date total return of –12.3 percent) and the yield of the 10-year U.S. Treasury note declined 17 basis points to 3.99 percent.
New Home Sales: Sales of newly constructed homes declined 2.5 percent last month, from a downwardly revised, seasonally adjusted annual rate of 525,000 units in April to just 512,000 in May.

On a year-over-year basis, sales are currently down a whopping 40.3 percent and, from the peak in July of 2005, sales volume has declined 64 percent.

Aside from the March total of 501,000 two months before, sales levels have not been this low since 1991 when the population of the U.S. was about 50 million less than it is today.
Prices for new homes fell to $231,000, a decline of 5.1 percent from last month and 5.7 percent below last year at this time. Note that the median sales price data for new homes has become increasingly erratic in recent months and, due to continuing cancellations and ever larger builder incentives, this data point contains little or no value for analytical purposes.

The most important piece of information in this report is that sales continue to decline faster than inventory, resulting in an uptick in the "months of supply" statistic, from 10.7 in April to 10.9 months in May. Until there is a significant reduction in inventory relative to sales volume, look for prices to continue to fall.

Durable Goods Orders: As expected, new orders for durable goods were unchanged in May after a downwardly revised decline of 1.0 percent in April. Excluding the always-volatile transportation sector, new orders dropped 0.9 percent following a surge of 1.9 percent the month before. On a year-over-year basis, durable goods orders have declined 1.5 percent, a figure that is not adjusted for inflation. Manufacturing remains in a funk, as corroborated by the many other reports on declining activity and falling employment, and would be even worse if not for the increased demand for exported goods.

Real Gross Domestic Product: The more you look at economic growth as measured by the quarterly change to gross domestic product, the more you realize how much value this data series has lost as an indicator of the health of the economy due to the many and varied contortions that the inflation calculations have undergone through the years.

In the final estimate for the first quarter prior to the annual revision later this year, real economic growth was revised upward from an annualized rate of 0.9 percent to 1.0 percent making Q1 the third quarter in the last five with real GDP of one percent or less.
The price deflator or "chain price index", used to convert "nominal" GDP to "real" GDP, also rose slightly from 2.6 percent to 2.7 percent. Note that if one were to plug a more realistic measure for rising prices into the "real economic growth" calculation, it's easy to see how we could be "mired in a recession" as the term is commonly (but incorrectly) defined - two consecutive quarters of negative economic growth.

Attention will now shift to next month's "advance" estimate for economic growth during the second quarter, to be followed by the "preliminary" estimate and the "final" estimate in subsequent months. Current estimates for the second quarter are for real growth of between one and two percent.

Existing Home Sales: Sales of existing homes rose 2.0 percent in May to a seasonally adjusted, annualized rate of 4.99 million units, 15.9 percent lower than last year at this time. The inventory of unsold homes remains historically high, down slightly from 11.2 months in April to 10.8 months in May.

The national median existing-home price fell to $208,600 in May, down 6.3 percent from a year ago when the median was $222,700. Home prices have fallen most in the West, down 16.0 percent over the last year, followed by a 4.3 percent decline in the Northeast.
Naturally, a few more ill-advised calls were heard last week that the recent data marks a "bottom" in housing. As shown in the chart, it may well be that a bottom in sales is nine months in the making, but prices will continue to decline for some time to come as an increasing number of monthly sales are now foreclosures or short sales.

An astonishing one-third of all existing homes sold last month were reportedly either foreclosure sales or short-sales and this figure likely understates the actual percentage of distressed home sales as some of these properties do not involve realtors and hence, are not included in the monthly data from the realtors' trade group.

The S&P Case-Shiller Home Price Index was also updated last week and year-over-year price declines were reported for all twenty cities in the index, led by 27 percent year-over-year price drops for both Las Vegas and Miami. For the usual colorful chart see this item from last Tuesday

Consumer Confidence/Sentiment: It just keeps getting worse and worse for consumers as both well-known measures of their mood - the Conference Board's Consumer Confidence Index and the Reuters/University of Michigan Consumer Sentiment Index - plumbed new lows.

Consumer Confidence fell to its fifth worst monthly reading in its 40 year history, down almost 15 percent from 58.2 in May to 50.4 in June with the expectations component at a record low of 41.0.
One year inflation expectations remained at 7.7 percent and, in a bad omen for next week's labor report, the number of respondents saying jobs are hard to get was double those saying they are plentiful - an extremely wide gap of 30.5 percent to 14.1 percent.

The final June reading on consumer sentiment fell to its third lowest reading of all time, this series going all the way back to 1952. The index fell three tenths of a percentage point from 56.7 at mid-month to 56.4, down from May's final reading of 59.8.

Inflation expectations over the next year were unchanged at 3.4 percent and, over five years, the outlook was for 5.1 percent annual inflation. These "inflation expectations" remain at very elevated levels due to soaring food and energy prices that are hitting consumers hard. There have been only a few other times when the mood of the consumer has been this foul.

Personal Income/Spending: Personal income and spending got a big boost from the tax rebate checks that were sent out in May with more to follow in June. Income rose 1.9 percent in May after a 0.3 percent increase in April and spending jumped 0.8 percent after a 0.4 percent increase the month prior. It's hard to get too excited about these increases as this is simply money borrowed by the government going out to consumers, much of which is spent on costlier food and energy.

Summary: While there may be a bottom forming in housing sales, housing prices remain in a virtual free-fall in many parts of the country as huge numbers of distressed properties continue to come onto the market. The housing market is still very, very troubled though you wouldn't know it by looking at the government's measure of economic well-being as understated inflation allowed first quarter GDP to remain positive, coming in at an even one percent.

Meanwhile, both income and spending rose last month but, more than anything else, this was a result of the delivery of half of the government's $100 billion in stimulus money. Look for more "stimulus" later this year.

As seen in the recent data on the mood of the consumer, now at multi-decade lows, Americans are well aware that there is something very seriously wrong with the economy and they don't see things improving anytime soon unless food and energy prices start going down and housing and stock prices go back up.

The Week Ahead: The coming week will be highlighted by reports on ISM Manufacturing on Tuesday and the labor report on Thursday. Also scheduled for release are reports on Chicago area manufacturing on Monday, construction spending on Tuesday, ADP employment on Wednesday, and the ISM nonmanufacturing report on Thursday.

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Oil and gold contest update #5

Can you stand the excitement? With one more trading day left in the fourth edition of the "Guess the price of oil and gold" contest, there has been just enough movement over the last week to shake up the top ten vaulting TP from seventh place to first.
Linda M was knocked out of the top spot, CW moved up one notch, and lookee who's there sneaking up into spot number four, maybe thinking about a last minute run with a bold guess of $145 for crude oil (the gold guess was a good one up until this morning).

Over the last week the price of oil rose from $135 a barrel to $140 and gold awoke from its recent slumber to tack on more than $25 to end the week at about $928.

In graphical form, the oil and gold prices have now looped back over themselves, once again heading to the upper right of the chart as might be expected in a world full of money backed by nothing other than faith in the government that issues it.
Recall that the winner will receive a free one-year subscription to the companion investment website Iacono Research, valued at $159, where the model portfolio had yet another good week, getting ready to close out the first half of the year with a gain of 7.5 percent.

The winner will be announced sometime on Monday afternoon or evening.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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Inflation protection - government vs. nature

Many of the not-so-bright bulbs in the investment community seem to recommend securing "inflation protection" from the government rather than from Mother Nature (see Money Magazine recommends commodities (kind of)). Here's a comparison of the two since TIPS (Treasury Inflation Protected Securities) became available in 1997.
The chart above uses the Lipper TIPS fund average from the Allianz Global website as a proxy for a TIPS investment. You can also get information on the Pimco Real Return fund (PRTNX) at the same location.

If you begin the comparison back in 2002 when gold should have come onto the radar screens of any open-minded investor who was paying attention, the difference in returns is even more dramatic.
So much for gold not paying any dividends.

Full Disclosure: Long gold, no position in TIPS at time of writing.



To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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Money Magazine recommends commodities (kind of)

It's only six percent and it's not really commodities, but commodity stocks instead, however, it is indeed one giant step forward for the nation's number one magazine on personal finance - a magazine that, to date, has generally been pretty clueless about investing in natural resources.

Now about seven years into what will likely be a 10 or 15 year secular bull market in commodities, Money Magazine has finally produced an investment portfolio pie-chart with a slice labeled ... wait for it ... Commodities.

Perhaps the editors were asleep or away on summer vacation already.

And were Jason Zweig and Michael Sivy consulted for this issue?

This report in Money Magazine came years earlier than anyone could have reasonably expected, though, since it technically falls short of recommending the purchase of commodities themselves and the allocation really is pitifully small, it can't really be interpreted as a "magazine cover" indication of a top.

Inflation: 4 ways to protect your assets
No matter how bad it gets, the same investing rules always apply: don't put all your nest eggs in one basket.
...
2. Commodities: Profiting from rising costs

One way to beat inflation is to own the stuff that's going up in price. Between 1973 and 1981, when inflation averaged 9%, the Goldman Sachs Commodity Index, which tracks oil, metals and food futures, averaged a 13% annual return. In just the past five years, commodity-driven mutual funds have gained an annual average of 30% vs. 10% for Standard & Poor's 500-stock index.

But those sizzling performance runs are matched by long periods of lousy returns - during the '80s and '90s, for example, returns were flat. And today these assets are trading at or near historically high levels.

"There are signs of a speculative bubble," says Jeremy DeGroot, chief investment officer at Litman/Gregory in Orinda, Calif. It's difficult to time when such a bubble might burst, but anyone who buys commodities should be prepared for steep setbacks. In 1998, when markets were hit by the Asian currency crisis, natural-resources funds lost an average of 25%.

Still, by gradually building up a 5% stake in commodities, you can lower your overall portfolio risk, says Lou Stanasolovich, a financial adviser in Pittsburgh. That's because commodities move out of sync with stocks, smoothing out your returns.

How to invest: The best approach is to buy funds that hold shares in energy companies and other stocks that benefit from inflation, such as T. Rowe Price New Era. You can also consider an ETF such as iShares S&P North American Natural Resources (IGE), which tracks an index of commodity-producing firms.

Treasury Inflation-Protected Securities (TIPS) topped the list with real estate and blue chip stocks placing third and fourth in what is generally a good first step in addressing how the investment climate is rapidly changing.

Of course, recommending a much bigger slice of natural resource investments a few years ago would have served their readers much better.

When Money Magazine starts talking about commodities like they talked about real estate back in the summer of 2005 (see Money Magazine Does Real Estate and don't miss the cover story about San Diego's hot market - Boomtown USA), then you'll know it's time to start thinking about paring your positions in natural resource investments.

To learn more about investing in natural resources using commonly traded ETFs, stocks, and mutual funds, see this description at Iacono Research. Or, sign up for a free trial.

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On the road again...

We've been having a look around in Southern Oregon for the last few days, hence the somewhat sporadic posting. Anyone with any tips on the area is encouraged to leave them in the comments section.

So far, our impression is that it is a lot like Northern California with more of the good qualities and less of the bad ones (of course you have to be away from the freeway to see any of these qualities).

Paying no sales tax rocks! I just hope that internet service is a lot faster in the rest of the state than it is in our hotel room.

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The pause that refreshes

Another Federal Reserve Open Market Committee group therapy session came to a merciful conclusion earlier today with no change to short-term interest rates for the first time since last fall when the current credit crisis began.

[Hey, wasn't that little three-month credit problem supposed to be over by now?]

With the Fed funds rate left at the freakishly low level of just two percent, Federal Reserve officials expressed renewed concerns about inflation but still expect it to moderate in the period ahead.

The last two policy statements are shown below:

Interestingly, given yesterday's report on home prices and today's report of even lower new home sales, the "deepening housing contraction" has been re-characterized as the "ongoing housing contraction" which, yes, is still expected to "weigh on economic growth" for a while.

On the subject of rising prices, this may go down as the longest continuous period of time for a central bank to wait for inflation to moderate - that's been the party line for the better part of two years now and it looks like another entry can now be added to this very long list of Fed expectations regarding inflation.

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Case-Shiller home prices

This update of the Case Shiller Home Price Index goes out to the folks over at Junk charts who seemed to like it so much last month - note that the x-axis scale has been fixed but there have been no changes to the drop-shadows.
There were a total of eight metropolitan areas with month-to-month gains, led by a 2.9 percent increase in Cleveland, but the more important year-over-year results showed declines in all 20 cities.

Las Vegas and Miami take top honors once again with declines of 26.8 and 26.7 percent, respectively, from year ago levels.

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