Weekly Economic Commentary: Week of February 6

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF FEBRUARY 6, 2012

Conventional wisdom has it that the economy will downshift in the current quarter from the 2.8 percent growth rate it posted in the final three months of 2011. While we concur with that prospect, the slowdown may be less severe than most expect. True, consumers - which account for about 70 percent of total activity - will probably not match the spending pace set in the fourth quarter of last year. One reason is simply based on arithmetic; real personal consumption declined in December, leaving it slightly below the average for the quarter. Hence, consumers will have to climb out of hole before a positive growth rate is reached. That's probable, but the monthly gains won't be large enough to bring the quarterly average up to the 2 percent gain set in the fourth quarter.

Secondly, an outsize fraction of the fourth-quarter increase in GDP was due to inventory restocking by businesses. Inventory accumulations accounted for more than 1.9 percent of the 2.8 percent overall growth rate during the period, something that is clearly unsustainable. But here is where the conventional wisdom may not hold up. Most believe that companies are now fully stocked and, wary of sales prospects, will meet demand by pulling merchandise off their shelves rather than increase orders for more goods. That line of reasoning would certainly be credible if demand turns out to be as weak as feared. Happily, however, such is not the case. As reported this week, auto sales hit the highest pace since May 2008, exports are holding up surprisingly well according to manufacturing reports, and new orders at factories jumped to a four-month high. The upshot: manufacturing activity as measured by the Institute for Supply Management index, surged to a nine month high in January. What's more, the purchasing managers surveyed in the report said that not only are their companies still adding to inventories, new orders for their goods are rising even faster. From our lens, this does not suggest a major reversal of the inventory buildup that boosted growth towards the end of last year.

To be sure, the case for a slowdown in the early part of 2012 is still compelling. The consumer-spending pullback in December reflected an attempt by households to shore up balance sheets. Recall that holiday purchases were financed largely by drawing down savings and piling on more debt, including padding credit card balances. By all accounts, this was a temporary deviation from a pattern underway throughout the recovery, namely one in which households are focused on paying down debt and rebuilding a savings cushion. We do not have data on consumer borrowing for December yet, but it is clear that consumers decided to stash a larger share of their paychecks into savings during the month. The personal savings rate, which fell from over 4 percent during the summer to 3.5 percent in November, leaped back to 4 percent in December. Odds are, the rate will move higher in coming months, even as households continue to reduce debt from still-high levels relative to incomes. That combination is a recipe for a slower spending pace during the early part of 2012.

But like the speculation regarding inventories, the logic for a sharp pullback in consumption may be undercut by emerging developments. Keep in mind that households can shore up balance sheets and still keep their wallets open if incomes are growing fast enough. Sadly, that was not the case throughout most of 2011, particularly when inflation is taken into account. Real disposable incomes edged up by a tepid 0.9 percent during the year, half the 1.8 percent gain registered in 2010 as rising energy, food and commodity prices cut deeply into purchasing power during the spring and summer months. But fortunes started to pick up late in the year, reflecting a combination of slowing inflation and faster income growth, propelled by an improving job market. In the fourth quarter, real disposable incomes turned positive again amid tangible signs that even stronger gains loom ahead.

That brighter prospect received strong support from the government's latest monthly jobs report released on Friday. The report just about blew away the consensus estimate for job creation, which was for a gain of roundly 135 thousand in nonfarm payrolls and for an unemployment rate to remain at a stubbornly elevated 8.5 percent in January. Had the consensus been correct, it would have solidified the notion that the job market is showing steady if slow improvement, with the operative word being "slow". But Friday's report may spur economists to start thinking of different adjectives to describe the job market. In January, the economy generated 243 thousand net new jobs, far stronger than expected even as back figures were revised higher; the revisions added 60 thousand workers to payrolls during November and December. Meanwhile, the separate survey of households shows that the intractably high unemployment rate is not so intractable after all. In January, the jobless rate fell again for the fifth consecutive month, declining to 8.3 percent from 8.5 percent in December. That's the lowest since January 2009 and down by nearly a full percentage point over the past five months.

It is hard not to wax superlatives over the latest job numbers. Ordinarily, economists like to parse these reports to find reasons for caution, citing the age-old adage that the "devil is in the details." This time, however, the details are as impressive as the headlines; in some cases, even more so. For one, the outsize gain in jobs last month was not skewed by one or two industries. The increase was broad-based, with virtually every super sector participating in the hiring spree. One measure of industry participation is the diffusion index, which tracks the percentage of private industries expanding payrolls; a number of 50 indicates that as many industries are adding jobs as are shedding them. In January, the index hit 64.1, the highest since last April and a level usually associated with a healthy labor market. Indeed, just about the only sector that continues to retrench is the government, where another 14 thousand pink slips were issued in January. The layoffs here are concentrated mainly among municipal workers, as financially-strapped local governments continue to purge the ranks of teachers and other educational workers. Sadly, this trend shows no signs of easing in the near term.

Elsewhere, however, the positive surprises were in abundance. The factory sector, which is supposed to be feeling the heat from the global slowdown and the aforementioned inventory pullback, added a robust 50 thousand jobs on top of the 32 thousand gained in December. Autoworkers are benefiting immensely from the sudden revival in car and truck sales, but the factory floors are humming due to solid orders from overseas as well as from domestic companies revving up capital outlays. Clearly, manufacturers have stressed productivity over the years, finding that they can produce goods with far fewer workers than in the past. Hence, although more than 400 thousand manufacturing jobs have been created during the recovery, that pales in comparison to the 2.3 million jobs lost during the recession. Those jobs will never be fully recovered, but even a more productive manufacturing sector will need more labor as output increases.

Indeed, the objective of operating with as mean and lean a staff of workers may have gone as far as it can go in this cycle. Not only have manufacturers added a robust 50 thousand net new jobs in January, they are requiring workers to put in much longer hours. During the month, the average workweek on the factory floor jumped to 41.9 hours from 41.6 hours in December. This is a huge monthly increase and, as the chart shows, the workweek now matches the longest for any month in more than sixty years. Needless to say, you can squeeze just so much output out of given workforce; with hours stretched to such lengths, future production gains will require companies to take on a proportionately larger number of new workers.

Even the ailing construction industry is starting to pick up hiring again. For the first time since 2006, hiring has exceeded layoffs for three consecutive months. In January, construction payrolls increased by 21 thousand following a 31 thousand gain in December and a much smaller 1 thousand increase in November. The December/January increase was the largest for a two-month period since March/April 2006, the tail end of the housing bubble. To be sure, like manufacturing the 2.2 million construction jobs that evaporated during the housing bust will not be recovered in the foreseeable future. But the long drought seems to be over for these beleaguered workers. And, while the shrunken housing sector has a much smaller influence on the overall economy than it did at the peak of the housing bubble five years ago, it still has knock-on effects on other industries. One example: the rebound in light truck sales in recent months may well be a direct result of newly-employed contractors in the construction industry needing vehicles to transport supplies and materials.

Crossing over to the household survey, which generates the unemployment rate, the news is just as positive as it is in the establishment survey. The headline drop to 8.5 percent will, no doubt, garner most attention in the business media, but it is important to note that the decline occurred for the right reason. In recent months, skeptics pointed out - rightly so - that the fall in the unemployment rate was due less to a pickup in job growth than an increase in the number of workers dropping out of the labor force. That charge cannot be leveled at the January report. True, the labor force participation rate fell again, but only because the Labor Department adjusted the composition of the labor force to account for new population controls coming out of the latest Census count. In effect, more workers aged 55 and over are now included, an age group that has a lower proportion in the labor force.

Looking at the larger picture, the employment/population ratio remained unchanged from the previous months and the labor force actually increased by 508 thousand in January. The good news is that under the household survey employment jumped by an even larger 847 thousand, moving 339 thousand workers off of the unemployment rolls. The Labor Department also adjusts its measure of household employment to more closely mimic the definition of nonfarm payrolls generated in the establishment survey. According to this adjusted gauge, employment surged by over 1 million workers last month, far greater than the 243 thousand gain posted in the establishment survey. The household gains have been stronger for the past six months, leading many to believe that the establishment figures have some catching up to do.

We hate to end an otherwise sterling jobs commentary on a down note, but it would be remiss of us not to point out that the wounds in the labor market still run deep and the healing process is only in its early innings. The most troubling element continues to be the plight of the long-term unemployed, which hardly improved last month. There remain 5.5 million workers who have been out of a job for more than six months, which is a whopping 43.3 percent of unemployed people. This is the same share as two years ago, and off only slightly from the record 44.7 percent of last May. When Fed chairman Bernanke says progress on the labor front has been frustratingly slow, this is the metric he is most concerned about. Hopefully if the surprisingly vigorous increase in job creation in January continues, it will start to trickle down to the hardest cases as well.

JPT020312-237

Weekly Economic Commentary: Week of January 30

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF JANUARY 30, 2011

The Federal Reserve commanded center stage this week, holding its regular policy-setting meeting and delivering on its highly-telegraphed promise to reveal the interest rate forecast of the 17 members of the Federal Open Market Committee over the next three years. Chairman Ben Bernake has long been an advocate of more transparency in the policy making process; this week, he followed through in spades, particularly with the remarkable honesty and openness with which he conveyed his thoughts in the press conference following the FOMC meeting. True, nothing terribly exciting or surprising came out of the policy session, but the markets nonetheless drew comfort just from the reaffirmation that the Fed will be keeping rates at rock-bottom levels over the foreseeable future, and stands ready to take more action if the economy falters.

Although not a surprise, the Fed formally revealed its intention to keep interest rates at its current near-zero level through at least late 2014. That's more than a year beyond the guidance it had previously announced, which extended through the middle of 2013. Not all of the Fed officials agreed with this timetable. When asked when the first rate hike would occur, six projected a policy firming before 2014 and six thought that it would happen later, with four looking to pull the trigger no earlier than 2015 and two in 2016. These projections, of course, are contingent on the economy's performance. Make no mistake, should the pace of growth, job creation and inflation deviate significantly from expectations, the Fed will act accordingly, lifting rates sooner or later than the given timetable. The point is, these interest-rate projections are just that - projections, not commitments.

As the table presented after the FOMC meeting shows, the Fed does not have high hopes for the economy over the next year or two. It actually revised lower its growth forecast for 2012 and 2013 from the one presented in November, although it also lowered its expectation for the unemployment rate. Overall, the Fed was slightly more upbeat about recent economic data, saying that the economy was "expanding moderately, notwithstanding some slowing in global growth". But it remained very cautious about the outlook, pointing out in its policy statement that, "While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed. Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable." The Statement also said, "Strains in global financial markets continue to pose significant downside risks to the economic outlook."

We were particularly interested in the Fed's views on inflation, both the outlook and the constraint it would impose on future policy decisions. As noted, it expects inflation to moderate next year and beyond, saying it " anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee's dual mandate" which is to promote price stability and maximum employment. What does it consider to be price stability? For the first time, the Fed gave a specific goal of 2 percent as the desired long run inflation rate, as measured by the personal consumption deflator. In the fourth quarter, the PCE deflator stood 2.6 percent above the level of a year earlier, but the pace slowed sharply over the second half of the year. Compared to the third quarter, the deflator increased by a 0.7 percent annual rate. As the above table shows, the Fed expects the PCE deflator to increase between 1.4 and 1.8 percent in 2012.

From our lens, the Fed's moderating inflation outlook combined with its belief that unemployment will remain unacceptably high in coming years opens the door for another round of quantitative easing. To be sure, Bernanke was cautious in the outlook for further accommodation in policy. But in the press conference following the FOMC meeting, he was specific in that the Fed would undertake more asset purchases "if warranted," although such action was not yet decided upon. He said he was "not ready to declare" the economy had entered a new, stronger phase" and that the FOMC was "prepared to take further steps if the recovery is faltering." Another round of asset purchases was "certainly on the table," and added that, "if conditions warrant, we will certainly consider using it."

Interestingly, Bernanke's guarded assessment of the economy may have seemed overly cautious a month or so ago when most indicators showed increasing vigor and pointed to a solid start to 2012. As a result of this apparent momentum, the odds seem to favor no further Fed action was needed to nourish the recovery. But incoming data over the past few weeks suggest that Bernanke may be correct in looking through the stronger data, believing they were more of a temporary blip rather than the start of a stronger growth trend. For example, the holiday shopping season did not live up to the heightened expectations promised by the blockbuster sales reported over the Black Friday weekend. Excluding autos, retail sales in December actually declined for the first time since May of 2010. Meanwhile, conditions in Europe deteriorated significantly, with knock-on effects on U.S. exports. Housing remains in the doldrums, with a slight uptick in starts and homebuilder sentiment offset by continued softness in sales and home prices.

As it turns out, the first snapshot of the economy's fourth-quarter's performance was somewhat disappointing. The Commerce Department released its advance estimate of GDP on Friday, and the result was weaker than expected. During the period, the economy grew at a 2.8 percent annual rate, a tad below the consensus forecast of a 3 percent growth rate. For the year as a whole, real GDP increased by 1.7 percent, down from 3.0 percent in 2010. By itself, the slowdown is not out of the ordinary, as the first full year of a recovery is usually the strongest, benefiting from a bounce-back from recession. But the first-year rebound was anemic by cyclical standards and the second-year slowdown merely highlights the sub-par nature of this ongoing recovery. The 2.8 percent growth rate in the fourth quarter does not even equal the economy's long-term growth trend of 3 percent.

The disappointing headline reading on GDP sounded a negative chord in the financial markets on Friday, adding to the downbeat news coming from overseas. But more than the headline, the details of the GDP report were particularly disturbing to those in the optimistic camp. Simply put, most of the gain in the fourth quarter came from a $58 billion inventory buildup. That contributed fully 1.94 percent to the overall 2.8 percent GDP increase. Excluding this volatile category, real final sales rose at an anemic 0.8 percent annual rate, the weakest since the first quarter of the year. Dragging down growth, business investment slowed considerably and government spending on both the federal and state and local levels posted outright declines. The Federal retrenchment was entirely in defense spending, which slumped by 12.5 percent and seems to have been related to the pullback of troops from Iraq. State and local spending fell by another 2.6 percent, marking the fifth consecutive quarter of falling outlays.

Aside from inventories, the biggest contribution to the GDP gain came from consumers. But even here, the news is not that encouraging. During the period, personal consumption increased at a 2.0 percent pace, better than the 1.7 percent and 0.7 percent increases posted in the third and second quarters, respectively. But the lion's share of the gain was for autos, which spurred a 14.8 percent advance in durable goods purchases. That's not a sustainable trend, as it reflects primarily a rebound from the summer when auto parts were in short supply due to the Japanese earthquake. In the much larger services sector, which accounts for 64 percent of total consumption, outlays increased by only 0.2 percent, the smallest gain since the third quarter of 2009. Keep in mind that the service sector is also the largest source of employment, so a slowdown here is not auger well for the job market.

What's more, the modest pick-up in personal consumption was driven largely by an increased usage of consumer debt and a pullback in the savings rate. We would feel more comfortable if spending was supported entirely by growing wages and salaries, with some left over to build up savings and repay debt. Since just the opposite took place in the fourth quarter there is a good chance that households will slow their spending in the first quarter, which more than anything will restrain growth during the period. We suspect that the potential for a consumer retrenchment weighed heavily in Bernanke's cautious assessment of economic prospects in coming quarters. The chairman has often expressed concern with the condition of household balance sheets, which are still highly leveraged.

We concur with that assessment, but are encouraged by two developments in the fourth quarter that may limit the extent of a spending pullback. First, the aforementioned slowing in inflation means that households got more bang for the buck for every dollar of income earned. Real disposable income increased for the first time since the opening quarter of last year, rising by 0.8 percent. That's not much, but the underlying trend in nominal incomes is also rising. Moreover, a greater share of the increase is coming from wages and salaries and less from government subsidies. Excluding transfer payments, real disposable income rose by a solid $60 billion, following a decline of $23.2 billion in the third quarter and a small $3.1 billion increase in the second quarter.

Simply put, the economy received a big lift from inventories last quarter, which is not likely to be repeated in the current quarter. That alone strongly suggests a pending slowdown in GDP during the opening months of the year. However, some of the drags that occurred last quarter should not be as severe, such as the eye opening drop in defense spending. It should also be noted that housing made a modest contribution to growth in the fourth quarter, which supports the notion that the long and pernicious drag from the residential sector is over. Another positive omen: while business investment spending slowed in the fourth quarter, it picked in the closing month of the year. Both new orders and shipments of nondefense capital goods, excluding aircraft, posted solid gains in December according to a government report released this week. No doubt, this week's data poured some cold water on the more optimistic expectations that had been building a few weeks ago. We suspect, however, that the fundamentals continue to improve and will support a decent growth rate in the neighborhood of 2 ½ percent this year. Unfortunately, that's not enough to significantly lower unemployment and, if inflation continues to recede as expected, the odds favor more Fed intervention in the foreseeable future.

JPT012712-176

Weekly Economic Commentary: Week of January 23

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF JANUARY 23, 2012

With the onslaught of incoming data rounding out activity for December it is almost time to close the books on 2011. To be sure, the fourth-quarter GDP report will not be released until next Friday, and that first estimate will be revised several times in coming months as information on missing pieces becomes available. But most key ingredients are already accounted for, providing us with a reasonably good picture of how the year wound up. In a nutshell, there were more positives than negatives during the closing months of the year, leaving the economic glass slightly more than half full.

Admittedly this is a modest accomplishment. At this stage of a cycle - more than two years into a recovery - the economy would ordinarily be expected to follow a much stronger growth path, gobbling up unused labor and productive resources and prodding policymakers into thinking about anti-inflation measures. But an array of natural and manmade shocks have prevented a normal recovery from materializing; what's more, the glass has been more than half empty for so long that there is little danger of it overfilling anytime soon. Instead, we are left wondering if more obstacles loom ahead, which would impede even the modest progress that seems to be underway.

The most visible and immediate threat is the intractable European debt crisis that continues to defy a solution. So far, the U.S. economy has not been deeply affected, although exports are already starting to suffer as a result of the sharp slowdown among our European trading partners. In November, exports to Europe, which accounts for more than 20 percent of total U.S. goods exports, plunged by more than $2 billion. The setback left European exports a mere 5.2 percent higher than a year-earlier; as recently as April, they were growing at more than a 25 percent annual rate. Needless to say, the pronounced drop in sales to Europe has made a dent in total merchandise exports, which are now growing at less than half the pace of six months ago.

No doubt, exports have been one of the few shining lights in the recovery, supporting a solid rebound in factory production that led the U.S. out of the Great Recession. Over the past 2-½ years, manufacturing output has increased at a 6 percent annual rate, more than double the 2.4 percent pace during the 2001-2009 expansion and an outsize premium relative to the 2.4 percent growth rate in GDP. The production rebound has spurred an equally impressive increase in factory jobs. Over the same period, manufacturers have added a sizeable 334,000 workers to payrolls, which actually understates the influence of this sector on the labor market. Keep in mind that when a new factory opens or expands, it tends to attract a Walmart, auto dealer or similar establishment with its own staffing needs. The reverse is usually not the case.

The good news is that factories continued to rev up as the year drew to a close, despite the throttling down of exports. As reported this week, total industrial production increased by a solid 0.4 percent, more than reversing a 0.3 percent drop in November that was dragged down by a drop in auto output, a volatile sector. The December gain was also held back by an aberrational drop in utility output due to unseasonably warm weather that slashed electricity consumption. More to the point, manufacturing output rebounded by a robust 0.9 percent, the strongest monthly increase in a year. The gain was broadly based, including a bounce back in auto output. But perhaps the most encouraging aspect of the report was the continued gain in business equipment output, which may fill the void left by the expected slowdown linked to weakening exports.

Along with exports, capital spending has been one of the few bright spots in the recovery. Since the recession ended, spending on equipment and software has increased at a robust 13.7 percent annual rate. Not only is that the strongest pace registered in all but one expansion since 1960 (the 13.9 percent in the 1971-73 upturn), it kicked in at a much earlier stage of the recovery than usual. Normally, capital spending picks up several quarters after a recession ends, following a rebound in consumer spending that eats up unused capacity. The quick revival this time was sparked by a huge replacement demand for aging equipment and software, as the collapse in capital spending during the recession was the longest and steepest ever recorded during the post war period. While special tax incentives also fueled the upsurge, companies enjoyed a robust gain in profits and cash flow that easily financed the spending increase. Exceptionally low borrowing costs and a receptive bond market also helped. Except for the expired tax incentives, these favorable conditions remain mostly in place, so the recovery in capital spending should continue to support growth in the coming year.

Clearly, the U.S. will have to rely more on internal sources to drive growth in 2012 than was the case over the past two years. Not only is Europe on the cusp of a recession, if not already in one, most emerging market nations - the fastest growing export destination for U.S. products - are also experiencing weaker growth. China - the third largest export market for U.S goods - has cooled down considerably, thanks to aggressive anti-inflation steps taken by the government; growth in Brazil has stagnated, and other developing Latin American countries are suffering from falling commodity prices, a normal cyclical response to weakening global demand. What's more, the sovereign debt struggles of the weaker euro zone members have sent the region's currency on a deep slide. Although it recovered somewhat this week, the euro recently hit a 16-month low. That's because uncertainty over how the debt woes will play out has caused investors and traders to flee the currency and place their funds in safer havens, particularly dollar-denominated assets. As a result, the dollar has strengthened, which makes U.S. goods more expensive on the global market place, reinforcing the drag on exports.

The question is whether the U.S. can find enough strength among domestic sources to drive the recovery on to a faster growth track. Most economists expect that growth will speed up from the tepid 1.8 percent pace estimated for 2011. Few, however, believe that the acceleration will be anything but modest. We concur. There are still too many headwinds that are visible, and some that remain under the radar, including the risk of a "credit event" should the euro debt crisis spread to the U.S. financial system. As encouraging as the relatively strong holiday shopping season was, we are skeptical that consumers can sustain more than a trend-like pace of expenditures over the next several quarters. Indeed, households took on an astonishing amount of new credit in November and sharply drew down savings to finance their holiday purchases. If that behavior is a sign that consumers are more confident in their financial position and income prospects, the spending outlook becomes more positive. If, however, consumers borrowed more and drew on savings just to make ends meet in the face of lagging incomes, some payback can be expected with a spending cutback a likely outcome.

At best, therefore, the huge household sector promises a mixed bag of possible outcomes. Our sense is that some pullback will take place in the first quarter, but it will be more of a pause than a fundamental retrenchment based on worsening income or balance sheet conditions. By all accounts, the job market is improving, a trend confirmed by this week's report of a sharp drop in initial claims for unemployment benefits. To be sure, even a pickup in job growth in coming months will not fatten the collective paychecks of workers as much as would ordinarily be the case. With so much competition for jobs coming from a huge pool of unemployed and underemployed workers, labor has little bargaining strength to push for significant pay raises. That said, hourly earnings are creeping up as are hours worked. In December, average hourly earnings of all private workers rose by 0.2 percent, which is spot on with the average monthly pace for 2011 as a whole. The big difference, however, is that workers got to keep all of the increase because inflation was flat in December.

Indeed, the purchasing power of households should enjoy a boost from both growing labor income as well as slowing inflation in 2012. The December reading for the consumer price index was the third consecutive month in which the CPI was either flat or showed a decline. Falling energy, particularly gasoline, prices contributed importantly to the leveling out of the inflation rate but the core CPI, which excludes volatile energy and food prices, has been exceptionally tame as well, rising by just 0.1 percent in December. Taking a longer perspective, the overall CPI stood 3 percent higher than its year-earlier level, down sharply from the 3.9 percent pace seen as recently as September.

True, the core CPI edged up to a 2.2 percent annual rate in December, more than double the pace that prevailed at the end of 2010. However, it would be misguided to view this increase as the seeds of an inflation flare-up that warrants a countermove by the Federal Reserve. Keep in mind that throughout 2010 and the early months of 2011, the major objective of the Fed was to prevent the U.S. from falling into a deflationary spiral that is extremely difficult to arrest once it gets underway. Hence, while a doubling of the core inflation rate may seem ominous on the surface, it actually represents a success story for the Fed, as it moves the nation further away from the deflationary precipice. As it is, the current inflation rate is well within the Fed's target zone, giving it the flexibility to retain an easy monetary policy for as long as it takes to get the economy on a firmer growth path.

However, while the Fed has been successful in staving off deflation, it has been equally unsuccessful in lifting housing activity out of the doldrums. As this week's figures on housing starts illustrates, 2011 was the worst year on record for new single-family construction and permits. The ongoing housing depression, fueled by a huge pipeline of foreclosures, weak sales, persistent home price declines and restrictive credit conditions, was both the catalyst for the recession and the major drag on growth throughout the recovery. The good news is that the housing meltdown hit bottom several months ago, and a modest revival is getting underway. Sales are picking up, homebuilder sentiment is improving and new construction for single-family homes has turned the corner. Single-family starts increased for the third consecutive month in December, accompanied by a similar run-up in building permits. Homebuilding stocks have been one of the best performing sectors in the market over the past three months, reflecting investor confidence that housing is no longer the caboose holding back the economy's growth engine. No doubt, the removal of housing as an impediment to growth would be a welcome development for a recovery that faces enough hurdles as it is.

JPT012012-128

Weekly Economic Commentary: Week of January 17

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF JANUARY 17, 2012

The euphoria that accompanied last week's better-than-expected employment report subsided this week, thanks largely to escalating concerns over the European debt crisis, highlighted by a looming ratings downgrade of the sovereign debt of several EU nations. This tapering off in investor expectations is not all that bad, in our view, as it brings perceptions more in line with reality. Keep in mind that the markets' tend to overreact to changing events, often setting themselves up for disappointment when conditions do not live up to expectations. During the early months of both 2010 and 2011, most pundits were certain that the economy was moving onto a fast track, finally leaving bitter memories of the Great Recession in the dust. Alas, after a fast start following strong finishes to the previous years, the economy eventually sputtered and left overly optimistic investors in a veil of tears. In both years, stock prices rallied through the spring, and then went into a tailspin before recovering in later months when a fresh burst of optimism filled the air.

Perhaps investors, wary of past disappointments, are adopting a more sober attitude this time, one that is more in line with unfolding developments and sensitive to the array of uncertainties that lie ahead. As was the case in 2009 and 2010, the economy ended 2011 on a stronger footing, sparking optimism that the recovery was finally entering a self-reinforcing stage of faster growth and robust job creation. But unlike the start of the previous two years, the markets are approaching 2012 with some trepidation. And for good reason, as it is impossible to ignore the powerful headwinds that continue to stand in the way of a more robust recovery. Clearly, the European debt crisis tops the list, creating uncertainty over its ramifications for global growth as well as for the financial system. Ironically, conditions in the European markets actually seemed to stabilize in recent weeks following the aggressive - and surprising - move by the ECB to provide more than 500 banks with a huge $640 billion of three-year loans at a rock bottom 1 percent rate.

This massive injection of liquidity - and promises of more to come - did have a soothing effect on market fears as it temporarily lessened the threat of a liquidity crisis that could lead to a growth-stifling credit crunch. It also raised hopes that the banks would use a big portion of their newfound liquidity to invest in sovereign debt, thus easing the deficit-financing struggles of the weaker nations in the region. Indeed, there are indications that both Spain and Italy, two of the more debt-ridden members at the heart of the crisis, benefited from the European Central Bank actions. Both countries conducted debt auctions this week, obtaining funds at significantly lower rates than in previous sales. But widespread reports on Friday that S&P would soon downgrade the debt of many countries using the euro dashed hopes that the crisis was close to being resolved.

The news should not have come as a surprise, as the rating agency had issued such a warning on December 5, which sent the markets reeling at the time. Underscoring S&P's concern is the ongoing dissonance among European leaders over how to ease the crisis as well as the diminishing prospects for European growth. The latter fear was reinforced this week by incoming economic reports, which revealed that growth in the EU actually contracted in the fourth quarter. More and more, it looks like Europe is on the cusp of a recession, if not already in one. The embattled euro continued to slide, hitting a 16-month low of $1.23 on Friday, and yields on Spanish and Italian debt surged in the secondary market following news of the imminent downgrade. Simply put, the European debt drama has entered another chapter and it remains unclear how this sorry tale will eventually end.

That's not good news for the U.S. economy for a number of reasons. The most immediate consequence of the recession-prone European region is that it will curtail U.S. exports, which has been one of the bright spots of the recovery over the past year. On a broader scale, if European banks take a big hit to their balance sheets due to losses on debt holdings or from soured loans, American banks would surely be impacted as they are closely linked with their European counterparts via derivative contracts and other transactions. The globalization of the financial markets has been one of the primary engines of growth over the past two decades, but like most transformative events it has a downside as well as an upside. Since the 2008 financial crisis, governments and policy makers have been grappling with the downside for the first time and are still searching for the right solutions to a new problem.

Assuming that the European crisis does not accelerate to the point that results in a break up of the single currency zone, the U.S. should be able to weather the storm. But the crisis is clearly not going away anytime soon, and its lingering effects are one reason to be cautious about the U.S. economic outlook for the coming year. The others are mainly homegrown. Keep in mind that the recent sources of optimism - a strengthening job market, firmer consumer spending and improving household confidence - are eerily similar to the events that transpired over the past two years. On Friday, the Reuters/University of Michigan Consumer Sentiment Index was released, revealing a sharp improvement in the mood of households in early January. This follows a solid jump in December that was mirrored by the Conference Board's measure of consumer confidence. As the chart shows, similar increases were observed around the turn of the year in both 2010 and 2011, suggesting a sustained pickup in economic growth that never materialized.

Not surprisingly, in both instances households believed that job prospects were improving, reflecting strengthening reports on the labor market. In December 2010, for example, the unemployment rate fell by a sizeable 0.4 percent to 9.4 percent, beginning a four month stretch that left the rate almost a full percentage point lower than the 9.8 percent November level. That was accompanied by a burst of job creation through the spring, which was slashed by more than half over the summer months. Likewise, households entered 2012 riding a similar wave of optimism about the job market. As reported last week, the unemployment rate plunged by 0.5 percent in December to 8.5 percent, the lowest since February 2009. Equally encouraging was a pickup in job creation to 200 thousand, which far exceeded the 130 average monthly gain over the January-November period.

The question is whether households are setting themselves up for another round of disappointment, similar to the setbacks they faced in 2010 and 2011 that turned optimism into despair. Indeed, the sparse bucket of data released this week struck a sobering note, helping to defuse the market euphoria following last week's upbeat jobs report. For one, initial claims for jobless benefits jumped up in the first week of January, interrupting an extended period of persistent declines that nurtured hopes of a strengthening labor market. The increase supported the claim by skeptics that December's solid jobs report reflected mainly an outsize increase in hiring of couriers delivering goods purchased online over the holiday season. Their argument is that these temporary workers would be laid off after the seasonal bulge, leading to a lengthening of the unemployment lines once again.

For another, the retail sales figures for December suggest that the hoopla surrounding the holiday shopping season was more hype than substance. On Thursday, it was reported that retail sales in December edged up by a miniscule 0.1 percent, weaker than expected and hardly representative of a blockbuster sales season. If not for a solid 1.5 percent gain in auto sales, the picture would be worse. Excluding the auto sector, retail sales actually fell 0.2 percent in the final month of the year, the first such decline in eighteen months. Since consumers account for about 70 percent of total economic activity, from this perspective it would seem that there is not much momentum driving growth as the curtain rises on 2012.

We agree that the economy is not riding a wave of momentum that will generate a sustained pace of above trend growth in the immediate future. However, the threat of an abrupt slowdown based on this week's reports is also greatly exaggerated. A one-week spike in unemployment claims is not enough to draw any conclusions about labor market conditions, especially around the turn of the year when seasonal influences can distort the fundamental trend. There was a sufficient amount of positive elements in the December jobs report - higher earnings and a longer workweek, for example - to indicate that the recent strengthening in the job market is real. What's more, recent surveys of small businesses show a marked improvement in confidence and actual conditions. If small businesses are about to ramp up hiring, a major missing cylinder in the job-creating engine will be in place. These companies are not always included in the first calculation of payrolls by the Labor Department, which may explain why back figures on jobs are now being revised up more frequently.

With regards to the latest retail sales figures, here too it is tempting to jump to conclusions that may not reflect actual developments. True, the December reading was weak on the surface, but the November increase was revised up from 0.2 percent to 0.4 percent and October from 0.6 percent to 0.7 percent. What this tells us is that consumers frontloaded their holiday shopping plans, lured by aggressive price discounts and promotions. Even with the December slowdown, retail sales for the fourth quarter staged an impressive 7.9 percent annual rate of gain, much stronger than the 4.7 percent increase posted in both the second and third quarters. Keep in mind also that part of the nominal sales weakness in December can be attributed to lower prices, particularly at gasoline stations. Hence, in real terms, retail sales probably showed a larger gain. One other fact to consider is that gift cards play an ever-larger role during the holiday season, and these are not recorded as sales until they are actually exchanged for merchandise. If past trends continue, this could result in a solid boost to sales in January.

To be sure, households still have many fences to mend before they feel comfortable about aggressively stepping up their spending propensities. Home values continue sag, sapping housing equity and leaving millions of homeowners with more debt than their homes are worth. Savings are still too low. After rising from a low point of under 1 percent in 2005 to over 8 percent during the recession, the savings rate stabilized around 5 percent in 2010 and most of 2011. However, it fell to 3.5 percent over the past three months, and households will probably strive to rebuild a financial cushion, which will restrain spending. That said, the urgency to repair balance sheets should gradually fade as the economy continues to improve and instill a greater sense of confidence in job and income prospects. One sign that households are feeling more comfortable with their financial condition is the astonishing increase in consumer borrowing that took place in November. During the month, consumer credit surged by $20.4 billion, the largest monthly increase since November 2001. That included a $5.6 billion jump in installment credit, the third consecutive monthly gain. We doubt that the love affair with credit cards has returned in full bloom, but just the fact that households are willing to use plastic again after nearly three years of repayments is a sign that consumers are getting a bit tired of being overly frugal. If that sentiment persists, the economy has a good chance of weathering the storms blowing in from overseas.

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J.P. Turner & Company Exceeded Their Fundraising Goal for The Empty Stocking Fund

For the fourth year in a row, J.P. Turner raised more than $10,000 for the charity.

For J.P. Turner owners Tim McAfee and Bill Mello, the holidays are a time for showing appreciation to their employees and registered representatives and encouraging them to help those less fortunate.

For the fourth consecutive year, McAfee and Mello spearheaded a campaign to raise $10,000 for The Empty Stocking Fund, a charitable organization that provides Christmas presents to underprivileged children in the Atlanta area, by matching employee contributions dollar for dollar.

Without hesitation, donations poured in from home office employees and representatives across the country – from Florida to New York, Iowa to California– in support of the campaign. The firm once again exceeded its goal of  $10,000 and, as a result, helped provide gifts for nearly 520 children this Christmas. Over the past four years, J.P. Turner has raised more than $40,000 for the organization, and helped to ensure more than 2,000 Atlanta-area children had presents under the tree Christmas morning.

“Tim and Bill’s generosity is inspiring,” said Dean Vernoia, chief operating officer. “Most people use the current state of the economy as an excuse to do less for their employees and their community– Tim and Bill don’t. They understand the importance of investing in people inside their firm and in their community. The fact that we once again exceeded our goal was not surprising to me. All of us are just trying to pay forward the generosity they continue to show us during these tough economic times.”

“This year, The Empty Stocking Fund distributed gift packages consisting of two toys or gifts, a book and a pair of socks for 53,660 metro Atlanta children living in poverty - 3,300 more than last year (and with one less day). Demand was so high that, for the first time in recent history, The Empty Stocking Fund had to make a second, mid-season purchase to ensure we were able to serve every family that came to us for assistance,” explained Manda Hunt, program director. “Without the continued financial support of companies like J.P. Turner & Co., this last-minute increase wouldn’t have been possible and we might have had to turn hundreds of families away empty-handed.”

The Empty Stocking Fund has been bringing holiday cheer to metro Atlanta’s underprivileged children since 1927. Each year, the generous contributions received from thousands of Atlanta citizens along with local businesses and foundations enable the non-profit organization to provide gifts for tens of thousands of children from birth to13 years of age living in Clayton, Cobb, DeKalb, Douglas, Fayette, Fulton, Gwinnett, Henry and Rockdale counties. To learn more about the Empty Stocking Fund visit www.emptystockingfund.org. The Empty Stocking Fund is still in need. Donations are accepted year round. Please consider making a donation today.

J.P. Turner & Company, LLC, is a full-service investment banking, securities brokerage and advisory services firm headquartered in Atlanta with some 200 branch offices nationwide. The firm was named One of the Best Places to Work in Georgia for 2010 and 2011 by Georgia Trend Magazine. J.P. Turner was founded in 1997 by Bill Mello and Tim McAfee, who have assembled a strong leadership team composed of seasoned financial brokers and advisors, like themselves, that truly understand the challenges faced by independent representatives in the field. The company is a member of SIPC, TICA and the National Investment Banking Association. J.P. Turner has been consistently voted one of the top 50 independent broker/dealers by Investment News. For additional information on J.P. Turner & Company visit www.jpturner.com.

Weekly Economic Commentary: Week of January 9

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF JANUARY 9, 2012

The financial community woke up on the first day of 2012 facing a blizzard of data that for the most part rang in the new year on a positive note. Not surprisingly, the stock market started the trading year with a bang, staging a meaningful rally that soothed whatever hangover investors may have had from their holiday parties. Whether this is an opening salvo portending good times ahead or an overly optimistic assessment based on recent data remains to be seen. No doubt, the economy exited the year on a tailwind of momentum that fueled a sense of optimism heading into 2012. But the headwinds that buffeted the economic landscape throughout 2011 have not disappeared, and their continued presence casts a dark cloud over the outlook.

Putting aside those headwinds for a moment, it is clear that things have been looking up for the U.S. economy in recent months. By all accounts, the holiday shopping season was a success, as consumers opened up their wallets and purses to take advantage of deep discounts offered by retailers. The price incentives gave a solid lift to sales, which is likely to translate into a stronger growth rate for GDP during the fourth quarter than perceived a month or so ago. To be sure, the sales strength came at the expense of some profits, but retailers had to clear out inventories before putting in orders for spring merchandise. Early indications are that bookings will be relatively strong. For example, purchasing managers for the nation's largest manufacturers reported a sizeable increase in new orders during December. According to the Institute for Supply Management, the new orders component of the ISM manufacturing index rose to 57.6, an eight-month high. Only a few short months ago, the new-orders index had been below 50, indicating contraction, stuck at 49 from July through September.

The strength in the overall ISM manufacturing index and, to a lesser extent, its sister gauge for non-manufacturers was the first piece of good news to greet investors in 2012. As the chart shows the levels are far from robust, but a clear upward move is underway, which underscores a newfound sense of optimism over the economy's near-term direction. Nor is it the only indicator showing improvement. For a good part of last year, the construction industry had been scraping along the bottom, neither dragging the economy down nor providing a lift. Now, however, more signs are flashing green. As noted in recent commentaries, home sales and starts have been trending higher over the last few months, pointing to a slow recovery in the housing market. That perception received more confirmation this week as the government reported a much stronger increase in construction spending in November than expected. This series tends to be volatile from month to month and it would be premature to conclude that construction activity will provide the cyclical heft to growth typical during recoveries. But it is no longer the powerful offset to the positive influences that contribute to a self-sustaining upturn.

By far, the most important of those influences is jobs, and it is here that the news has been unequivocally upbeat. The December employment report, released Friday, not only revealed a larger increase in nonfarm payrolls than expected, the details were uniformly strong as well. During the final month of the year, the economy generated a 200 thousand increase in jobs, well above the expected 150 thousand and about 50 percent stronger than the 137 average monthly increase for the year. Importantly, the December gain was not concentrated in one or two sectors, but widely distributed throughout the economy. The diffusion index, which measures the percentage of industries that are expanding their workforce, jumped to 61.2 from 50.7 in November. Manufacturing, retailing and - yes - construction industries all expanded payrolls.

What's more, both average hourly earnings and the workweek ticked up, indicating a solid increase in wages and salaries during the month. A separate measure that captures the collective change in payrolls, hours worked and earnings surged by 0.7 percent, lifting the year-over-year gain to 4.5 percent. That's up from 4 percent in November and the largest annual increase in more than four years. It is also well ahead of the inflation rate, which should translate into higher purchasing power for workers. Indeed, that is where the rubber meets the road as far as the sustainability of consumer spending is concerned. One of the biggest question marks surrounding the robust holiday shopping season is whether households have the resources to keep on spending. With the savings rate falling and the use of credit cards rising, the fear is that consumers would retrench in coming months to rebuild savings and repay debt. They still may do that, but a solid increase in wages and salaries in December would provide a cushion to fall back on, enabling households to put aside some of their paycheck into savings accounts and still make trips to the malls and shopping centers.

To be sure, the surprising vigor of job growth in December comes with caveats. The weather was unseasonably warm during the month, which could have bolstered hiring in the construction industry where 17 thousand jobs were added compared to a 3 thousand average over the previous eleven months. Even more of an outlier was the outsize 42 thousand increase in jobs for couriers compared to a normal increase of 1 thousand a month. That gain reflects the increased preference of shoppers to make their holiday purchases online, which means more deliveries for Federal Express and UPS as well as the need for more couriers to drive the trucks and deliver the packages. The problem here is that most of those couriers might be let go in January as was the case following a similarly unusual hiring jump during last year's holiday season. We suspect that there will be some giveback this month as well, but there could also be a partial offset on the bricks and mortar side. With online shopping becoming more of a force in recent years, retailers may be responding by hiring fewer temporary workers over the holiday season to accommodate customers. If that's the case, there should be fewer layoffs in January than normally takes place, resulting in a seasonally adjusted stronger job figure for the month. We'll see.

Perhaps the best headline coming out of the jobs report is the surprising drop in the unemployment rate to 8.5 percent in December. The consensus of forecasters had expected an increase of a tenth of a point or so. One reason is the rate took an unexpected plunge from 9 percent to 8.6 percent the previous month, reflecting in large part a sizeable 120 thousand decline in the size of the labor force. The reasoning was that as the job market showed signs of improvement, more workers would join the labor force, pushing up the unemployment rate until those workers found jobs. Well, the labor force continued to shrink in December, this time by a smaller 50 thousand, sustaining the downward trend in the unemployment rate, with the 8.5 percent being the lowest since February 2009.

The slide in the unemployment rate should probably be taken with a healthy dose of skepticism, but it shouldn't detract from the overall improvement in the job market that seems to be well underway. Notwithstanding the shrinkage in the labor force, the jobless rate has now fallen in each of the past four months, which meets the condition for an underlying trend in our view. To be sure, the rate could well increase from time to time as discouraged workers decide that job prospects are good enough to resume their search. However, most economists would view a rebound in the labor force as a sign of strength, even if it pushes up the unemployment rate for a while.

It's also quite possible that an improving job market might not lure as many labor force dropouts back to employment agencies as is generally perceived. A closer look at the latest jobs report shows that the biggest contribution to the labor force shrinkage is coming from workers that have been unemployed for more than a year. This is probably related to the increasing numbers of out-of-work folks that have exhausted their long-term jobless benefits. As long as they are collecting unemployment checks, they are considered part of the labor force. Once those payments stop, many of those workers simply drop out of the labor force, deciding either to retire, return to school or pursue other endeavors. The point is, some fraction of those dropouts will not return to the work force, regardless of job prospects.

Hence, it would be misguided to expect the labor force participation rate to return to its pre-recession levels of over 66 percent from its current 30-year low of 64 percent. The economy was probably in an over employed condition during the bubble years prior to the Great Recession, even as it is underemployed today. Some reversion to the mean can be expected, but equilibrium below the prerecession level is the most likely resting place. The more pressing challenge will be to get the long-term unemployed back to work, which becomes ever more difficult as worker skills erode the longer they are out of work and the less attached they feel to the labor force. Even with the dropouts of long-term unemployed from the labor force, there are still 5.6 million workers who have been out of a job for more than 6 months, an unacceptably large 42.7 percent of the 13.1 million unemployed job seekers.

There are no easy solutions to the problem of the long-term unemployed, but a ramping up of job creation would certainly help, as would brisker home sales that would enhance worker mobility. With the possible givebacks that are likely to occur in January - courier layoffs and some pullback in construction hiring - there's a good chance that the monthly increase in payrolls will fall short of the 200 thousand gain posted in December. Hopefully, however, it will exceed the 125-150 thousand needed to keep up with population growth and prevent a resurgence in unemployment. Admittedly, the first to get hired will be those who have been unemployed for a short time; but as that pool dwindles, the door opens for those who have been out of work longer. There is a trickle down effect and the stronger is the pace of hiring, the quicker the benefits will flow down the labor pool.

But as noted at the outset, the economy faces many headwinds that could well deter companies from taking on as many workers as they otherwise would. The biggest gale force, as has been the case for several months now, is blowing in from overseas, as the euro-debt crisis continues to brew and underscore fears of another crisis. Add to that some homegrown worries, particularly the policy gridlock that is only hardening as the presidential election campaign heats up. No one expects major legislative initiatives to come out of Congress in coming months, but the temporary extension of the payroll tax cuts and emergency unemployment benefits expires in less than two months. If political paralysis prevents an agreement to extend these measures for the rest of the year, the economy could take a big hit. As the deadline approaches, companies will no doubt become increasingly apprehensive, as will investors. Uncertainty is the enemy of growth and an albatross around the financial markets. With so much at stake, we expect legislators to do the right thing, if only because inaction could backfire at the polls. For that reason we remain guardedly optimistic that the economy will continue to post modest and steady gains in 2012.

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Weekly Economic Commentary: Week of December 27

WEEKLY ECONOMIC COMMENTARY 

Stone & McCarthy Research Associates

WEEK OF DECEMBER 27, 2011

Due to the holidays, this will be the final weekly commentary of the year. We wish all our readers the happiest of holidays and a prosperous 2012.

Yes Virginia, there is a Santa Claus. After much saber-rattling and threats to never give in, the House Republicans finally came to their senses on Friday and agreed to the two-month extension of the Social Security payroll tax cut as well as to continue paying benefits to the long-term unemployed. We were pretty sure that rational minds would eventually prevail; but with Washington politics these days, you never know. The deal removes a near-term threat to the recovery, as a tax hike for 160 million workers as well as the cutoff of more than 2 million long-term unemployed from receiving jobless benefits would potentially siphon about three-quarters of a percentage point off the economy's growth rate. With the revised figures showing that real GDP increased by a 1.8 percent rate in the third quarter, that haircut is not something to dismiss out of hand.

To be sure, a two-month extension has its dark side. If the House and Senate leaders cannot agree on a full one-year extension over the next 60 days, the debacle will be revisited again early next year, resulting in more hand-ringing on Wall Street and much trepidation on Main Street. It would be nice to start the new year in a less turbulent environment than that which buffeted the economy over the first half of 2011. Keep in mind though that this is a presidential election year with many seats at stake in Congress; if nothing else politicians have demonstrated time and again that they will do whatever it takes to get elected - even if it is not in the best interest of the broader economy. So, keep your seat belts fastened.

More to the point, the resolution, however temporary, allows us the luxury of assuming that the topsy-turvy events in Washington will not derail unfolding developments on the economic front. Indeed, there are even hopeful signs that the euro debt crisis is entering a quieter stage -no resolution but no intensification of the crisis either -- which almost conjures up a sea of tranquility. That's because the European Central Bank is taking a more aggressive approach to the problem, extending an eye-opening $640 billion in three-year loans to more than 500 European banks at a 1 percent rate. The banks, in turn, are using a sizeable chunk of the loans to invest in sovereign debt, garnering a hefty return that exceeds the borrowing cost by a factor of at least 3. Not surprisingly, the strong demand by banks pushed the rate on short-term Spanish and Italian debt down sharply this week, which is precisely what the ECB was hoping to accomplish. Another side effect: The carry trade provides banks with a vehicle to beef up profits and, hence, much-needed capital, something that should inject investor confidence in the struggling industry. The Federal Reserve accomplished much the same thing with American banks following the 2008 financial crisis and, before that, the savings and loan crisis in the 1980s.

If the external shocks recede for a while, there is a better than even chance that the economy can ride the momentum built up over the second half of the year into 2012. Indeed, one engine of growth that has been sorely missing throughout the recovery may start to fire on more cylinders: housing. Make no mistake, the housing market remains in the throes of powerful headwinds that will keep it operating well below normal levels for some time to come. The foreclosure pipeline is still intolerably long, more than a fifth of homeowners with mortgages owe more than their property is worth, prices continue to slide and a broad swath of prospective buyers face tougher lending standards that disqualify them from getting a loan. Few industry analysts expect housing to make a meaningful rebound under these conditions.

But the free-fall that has played such a key role in dragging down the economy for the past four years appears to be over. True, home prices continue to slip, but this is a clearing mechanism that has to play out as long as there is an imbalance between supply and demand. What's more, the price declines are slowing and confined mostly to the distressed segment of the market where the excess supply is most pronounced. By virtually every other measure of activity, housing reached a bottom sometime over the summer and is now showing consistent signs of a modest recovery. This week's reports on construction and home sales confirmed that trend.

Housing starts in November jumped by a solid 9.3 percent to a 685 thousand unit annual rate, the highest level since April 2010 when the first-time home buyer tax credit jump-started activity. To be sure, the gain was paced by a 25.3 percent jump in multi-family construction, as single-family starts edged up by a much more modest 2.3 percent. The spike in multi-family starts comes as no surprise, as developers are taking advantage of the big increase in demand for rental units that has driven up rents. The multi-family segment of the market has been strengthening for several months, and the 238 thousand units started in November was the highest since October 2008. In the corresponding month last year, the annual rate of multifamily starts stood at just under 100 thousand units.

In contrast, the much larger single-family segment of the market is struggling to rebound, but even here the signs are promising. For one, single-family permits for future construction have posted solid gains for two consecutive months and now stand 15 percent above the low reached in March. For another, inventories of unsold homes are exceptionally low, thanks to the scant number of new homes to reach the market over the past several years. In November, only 158 thousand newly built homes were for sale, the lowest on record and less than half the normal inventory of unsold homes of about 300 - 350 thousand. At the current sales pace, it would take six months to remove all the unsold homes from the market, which is actually close to normal. The point is, with the absolute volume of inventories so low, only a modest uptick in sales would be needed to spur a rapid build-up in building activity.

Sadly, new home sales remain lackluster, owing largely to stiff competition from the existing home market where transactions can be made at deeply discounted prices due to foreclosures and distressed sales. But existing home sales are picking up steadily and inventories in the resale market are also being whittled down, suggesting that competition with the new-home market is lessening somewhat. What's more, builders are getting the message and starting to build smaller, cheaper homes that are finding favor with first-time buyers. Housing affordability is also near an all-time high, thanks to lower prices and astonishingly low mortgage rates. This week, the rate on 30-year fixed conventional mortgages fell to record low of 3.91 percent, nearly a full percentage point below the level of a year ago. Whether the housing market only grudgingly comes to life or belatedly moves on to a faster recovery track, as some industry observers believe, remains to be seen. At the very least, however, it is poised to make a positive contribution to economic growth in 2012, something that has not happened since 2006.

Even with a turnaround in housing, it would be a mistake to expect a rip-roaring start to 2012 that will ignite a full-bodied expansion over the rest of the year. There are too many misfiring cylinders in the economy's growth engine to support that outlook. State and local governments are still under considerable budget strains, and will continue to cut payrolls and other expenditures for some time to come. With Europe teetering on the edge of recession and growth in emerging-market nations slowing, U.S. exports will falter, taking some steam out of manufacturing activity. And notwithstanding the accord on the payroll tax cut reached this week, Washington will not be supportive of growth this year. If anything, fiscal policy will turn modestly restrictive as the stimulus measures passed in 2009 and 2010 continue to run out.

The key to the outlook rests with the job market and the behavior of households. Both are looking up, but neither can be relied on to provide much fuel to the growth engine. There is a good chance that the monthly increases in payrolls will top the 150 - 200 thousand monthly pace on a consistent basis during the year, which would be a considerable improvement over the 130 thousand average monthly gain seen over the first eleven months of 2011. But even with the recent slowdown in population growth, those prospective increases would make only a small dent in the 8.6 percent unemployment rate, which is being artificially suppressed by labor force dropouts. Indeed, the community of economic forecasters is about evenly split over whether the jobless rate will rise or fall from its current level by the end of next year.

To be sure, businesses would ramp up hiring far faster and more strongly than expected if consumers go on a sustained spending binge. However, that does not appear to be in the cards. Households are still striving to grow out of their huge debt burdens, a task that is being drawn out by the lackluster pace of income growth. In November, personal incomes eked out a meager 0.1 percent increase and real disposable incomes were unchanged from a month ago. Incomes are growing far too slowly to support a robust pace of consumption. True, real consumption spending is on track for a respectable gain of 2.5 percent or so for the fourth quarter, up from 1.7 percent in the third quarter. But the gain was financed by a drawdown in the savings rate, which is not sustainable as the housing meltdown and financial crisis left a deep hole in household balance sheets. We suspect that the improving job market will nurture a stronger pace of income growth, which should allow consumers to keep their wallets and purses open next year. The good news is that recession fears, so rampant over the summer, have moved off of the radar screen for now. The not-so-good news is that the economy remains vulnerable to some unforeseen shock that, given the turbulence over the past year, remains very much on the radar screen.

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