J.P. Turner & Company, LLC

2012-02-13T09:25:00.000-05:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF FEBRUARY 13, 2012

This time it's for keeps. That's what kids say when they really, really mean it. For sure, there are few kids among economic professionals who earn their living by forecasting the direction of the economy. But this time they seem to really, really mean it when they say that the economy is gaining momentum and heading for a self-sustaining expansion. Of course, they really, really meant it back in early 2010 and 2011 when they asserted much the same thing, only to wind up embarrassed when events didn't exactly go their way. Are they setting themselves up for another round of disappointing results? Or is the recovery this time for keeps?

Time will tell, as usual, but there is little question that a more optimistic sentiment has once again taken hold in the forecasting community. True, hardly anyone is predicting a blockbuster upturn this year. Certainly not the administration, which remains on the defensive following three years of underperformance relative to expectations and what now seems like bold predictions made by the president at the start of his four-year term. But even the president and his advisors are starting to feel more upbeat - and for good reason. Granted, the target of a 6 percent unemployment rate is out of reach; but that lofty goal was made before anyone realized how deep the recession would turn out to be, which drove the jobless rate to far higher levels than expected. While many reputable political analysts believe that the rate remains too elevated to salvage the president's election prospects this November, others believe that the direction underway will be just as important in swaying the voters.

If the latter is the case, Obama has reason to cheer. With last week's report showing a drop in the national unemployment rate to 8.3 percent in January, the downward movement from its nearby peak of 9.1 percent seen in August has been an eye-opener. Indeed, the 0.8 percentage point drop ranks among the steepest declines for a five-month period observed during postwar recoveries. Still, the labor market appeared to crank up twice before during the current recovery, only to fizzle out as the economy stalled. The latest example was just over a year ago, when the rate plunged by an even larger 0.9 percent between November 2010 and March 2011 and then stagnated over the next seven months. If that pattern repeats in coming months, the administration's hopes will no doubt be deflated again. However, there are positive signs pointing to continued progress as the year unfolds.

For one, the latest drop in the unemployment rate occurred for the right reason. For the most part, the erratic drop from the cyclical peak of 10 percent in October 2009 reflected as much a shrinking of the labor force as an increase in job creation. That led many skeptics to believe the statistical drop in the jobless rate was more an illusion than a fact. After all, if someone drops out of the labor force, he or she is no longer counted as unemployed. Between October 2008 and the end of last year, the size of the labor force fell by roundly 1 million workers, even as the population grew by more than six million. That discrepancy resulted in an ever-larger pool of folks outside of the labor market, notwithstanding the drop in the unemployment rate. But January's rate decline occurred despite a huge 508 thousand increase in the labor force. For once, companies expanded payrolls at an even faster rate.

To be sure, one-month does not make a trend and the labor force has a tendency to show wide gyrations from month to month. But if we keep an eye on the most important determinant of unemployment, the demand for workers by companies, things are looking much better than was the case a year ago. According to the latest figures issued by the Labor Department, the number of job openings surged in December, the latest month available. During the month, companies posted 3.37 million job openings, the highest since August 2008 and up from 3.12 million in November. As the chart shows, the trend has been decidedly upward since last spring, albeit in a jagged fashion. Likewise, the number of quits - a sign that workers are feeling more confident in job prospects elsewhere - has also been trending higher.

Unfortunately, actual hiring has not kept pace with the increase in job openings. Indeed, new hires actually fell in December, reversing most of the previous month's increase. There is no simple explanation for this lag. It may be that companies are having a hard time finding workers with the right skills needed for the jobs they want filled. A decline in labor mobility may also be a factor. The depressed housing market has kept many families stuck in hard-to-sell homes, preventing them from moving to where the jobs are. That said, it usually takes between 1-3 months for a company to fill a job listing. Assuming past patterns hold, the surge in job openings in December may largely explain the stronger-than-expected increase in net job creation in January reported last week. What's more, it may well portend another upside surprise in job growth in February assuming, of course, that the job openings surge in December holds up.

Another way of gauging the improvement in job prospects is to compare the number of job openings with the number of people seeking jobs. Many view this comparison as a barometer of the slack in the labor force. In December, there were 3.88 unemployed workers for every job opening, down from 4.27 in November. As can be seen in the chart, it's the first time this ratio has dipped below 4 since December 2008, and the latest month is well under the 6.93 high reached during the recession trough in July 2009. Simply put, some slack in the labor force has been taken up, which suggests that workers may soon be in a better bargaining position to obtain bigger pay raises. Still, there is a long way to go before a healthy balance between demand and supply of workers is established. A more normal ratio, representing a healthy job market, is one in which the ratio of job openings to unemployed workers is under 2. It will be a while before that threshold is reached.

One other portent of stronger hiring in coming months is simply that companies have squeezed as much output out of the existing workforce as possible. In the first quarter of 2010, nonfarm productivity surged to 6.2 percent compared to a year earlier, the highest since the fourth quarter of 1961 - nearly fifty years - following a robust annual increase of 5.3 percent in the previous quarter. Since then, however, it has been all downhill. By the fourth quarter of 2011, the year-over-year growth rate in nonfarm productivity slowed to a miniscule 0.5 percent. Needless to say, companies will have a hard time meeting demand by boosting productivity in the quarters ahead. For job seekers, that's good news as it offers hope that the latest surge in job openings is a manifestation of the growing need for labor.

So the pillars for an improving labor market would seem to be in place. The only question is, will the demand needed to sustain the recent strength in job creation remain firm. This is where the rubber meets the road, and where many skeptics believe is the Achilles heel of the recovery. Clearly, the retrenchment of consumer spending after sporadic bursts in both 2010 and 2011 played a major role in stalling out the nascent pickup in job growth during those years. Keep in mind though that households were firmly in the grip of a deleveraging process, paring debt that was aggressively acquired during the housing bubble years and required an outsize fraction of income to service. With debt repayments came spending restraint, particularly since real incomes were virtually stagnant during the period. The Federal Reserve, of course, exerted heroic efforts to stem the deleveraging tide, pushing interest rates down to rock-bottom levels, hoping to get consumers spending again.

In hindsight, those efforts were not successful, as households shunned debt-fueled spending in favor of restoring healthy balance sheets. This is a certainly a beneficial long-run development that even the Fed acknowledges, but it hampers the recovery in the short-run. That's especially the case when it is reinforced by fiscal austerity from federal as well as state and local governments, which has clearly been underway in recent years. However, the fruitless quest by the Fed to encourage consumers to borrow again may finally be bearing results. In the most recent two months, consumers have taken on an astonishing amount of new debt - to purchase autos, finance education and even to add balances to credit cards. In November and December, consumer credit jumped by a whopping $40 billion, the largest two-month increase in more than a decade.

To be sure, the latest borrowing binge has generated mixed feelings among analysts. Some believe that it is a temporary fluke related to holiday shopping and a desperate attempt to make ends meet until incomes can catch up. That may well be the case, particularly since the December borrowing surge seems inconsistent with the unchanged spending pattern seen during the month. But that's the half-empty view. Those who see consumer behavior through a half-full glass note that the borrowing upsurge was accompanied by a similar eye-opening increase in consumer confidence. Throw in the surprisingly strong employment numbers, and a case can be made that households are feeling better about prospects and are willing to take on more debt to satisfy pent-up demand for cars and other discretionary items.

So the question remains, is this recovery for keeps? Certainly, the internal dynamics are looking good - better job growth begets more income and confidence, leading to stronger demand that feeds back into more hiring. But the loop can easily be disrupted again by events beyond our control, such as another financial upheaval related to the never-ending European debt crisis, a spike in oil prices or an escalation of tensions in the Middle East with Iran at the center. Then there is the threat of a homegrown disturbance associated with ongoing squabbling in Washington during an election year. We remain hopeful that a deal can be forged in extending the payroll tax cut and long-term unemployment benefits, but time is running short as Congress goes on holiday recess at the end of next week. It looks like a permanent fix is not in the offing before then, but the odds favor at least a temporary extension that would avoid a confidence-shattering event. We hear that a bill with the ungainly moniker "The Temporary Payroll Tax Cut Continuation Act" is in the hopper for consideration next week. Stay tuned.

JPT021012-274

Weekly Economic Commentary: Week of February 6

2012-02-06T08:45:00.000-05:00

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

2012-01-30T09:42:00.001-05:00

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

2012-01-23T08:53:00.000-05:00

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

2012-01-17T09:04:00.000-05:00

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.

JPT011312-097

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

2012-01-13T15:14:00.000-05:00

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

2012-01-09T09:58:00.000-05:00

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.

JPT010612-060

Weekly Economic Commentary: Week of December 27

2011-12-28T15:27:00.000-05:00

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.

JPT122311-2101

Weekly Economic Commentary: Week of December 19

2011-12-19T08:26:00.000-05:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF DECEMBER 19, 2011

The financial markets had little to cheer about this week. Indeed, the drumbeat of negative shocks from overseas continued to sound a distressingly familiar note. Investors and currency traders dismissed last week's agreement among European leaders to impose fiscal discipline in the euro zone as being too little, too late and far from even becoming a reality. The disappointment drove up borrowing costs for Italy and sent the euro itself into a tailspin, falling below 1.30 for the first time since January. Many believe Europe is already on the first rung of a recession, which is starting to drag down growth in the stalwart emerging market countries, including China. Worse, none other than IMF chief Christine Lagarde warned that no country in the world is immune from the crisis and all must take steps to boost growth, "with risks of inaction including isolation and other elements reminiscent of the 1930s depression", a foreboding assertion indeed.

For a variety of reasons Ms. Lagarde's pro-growth message is falling on deaf ears. Europe, of course, is steadfastly adhering to austerity measures that not only retard growth but are likely to aggravate the very debt problem they are designed to cure. After all, austerity is just another name for contraction and contractionary policies inevitably bring about a contraction in economic activity. That, in turn, reduces tax revenues and countervailing efforts to raise tax rates only intensify the economic weakness that prevents nations from growing out of their debt burdens. To be sure, monetary stimulus can offset some of the fiscal austerity; but the European Central Bank is hamstrung by its singular mandate, which is to keep a lid on inflation. Indeed, a key reason the financial markets are skeptical the euro-debt crisis can be resolved is that the ECB has consistently refused to be the lender of last resort to financially-strapped EU nations, something that the austerity adherents, particularly Germany, fears would open the inflation floodgates.

The Federal Reserve, in contrast, is not as constrained, as it operates under the dual mandate of promoting maximum employment and low inflation. While it is more independent of the political process than the ECB, it is not immune from political pressure in Washington, where many critics of Fed actions reside. It is no secret that a vocal group of legislators believe the Fed has already gone too far in its pro-growth efforts, sowing the seeds of an inflation outbreak. Indeed, some of the presidential aspirants have called for the firing of Fed chief Bernanke. Nor are the pressures entirely external, as a handful of inflation hawks within the Fed have no doubt influenced policy decisions. Still, there is little question that the Fed has been decidedly more proactive in combating the growth-retarding shocks over the past four years than its European counterpart; what's more, it continues to assert that it will do whatever it takes to keep the U.S. economy afloat.

With the threat of recession trumping inflation for most of the period, the Fed has been able to justify its aggressive policies, overcoming the sporadic resistance both from within and outside the institution. However, with the U.S. more than two years into a recovery and the recession threat that loomed so large over the summer having receded, the question is whether more action to boost the economy will be forthcoming. That was the question overhanging the markets this week as the Fed's policy-setting committee met. No one expected any tangible action, but there was much speculation as to whether the policy statement would contain some hint that a third round of quantitative easing was in the works. When no such guidance was forthcoming, the stock market, already responding to negative news from Europe, came under further downward pressure on both Tuesday and Wednesday. The Fed, in essence, stayed with the message conveyed at its previous meeting, namely that the economy continues to expand modestly but is vulnerable to substantial downside risks, particularly from strains in the global financial markets.

So does that mean QE3 is off the table? Not exactly. From our lens, the Fed is still preoccupied more with the downside growth risks than with the upside inflation risks. True, some inflation gauges have recently turned higher. The most widely monitored one, the consumer price index, may even seem worrisome to inflation hawks. This week the Labor Department reported that the overall CPI was unchanged in November, thanks to weaker fuel prices, but the so-called core inflation rate, which excludes volatile energy and food prices, increased by 0.2 percent, the fastest in three months. It is the core rate, which is presumably more sensitive to fundamental economic conditions, that concerns the hawks.

As the chart shows, the annual rate of core inflation has crept up steadily this year, reaching 2.2 percent in November. That's the highest pace in more than three years and more than double the 0.8 percent pace of a year earlier. It is also higher than the Fed's comfort zone of 2 percent, which would argue for a more cautious monetary policy going forward. But that argument is not very compelling for a number of reasons. First, the climb in the annual core inflation rate reflects some lagged pass-through effects of the spike in energy and other commodity prices earlier in the year, which are now receding. For another, the core rate is heavily influenced by housing prices, which are being driven up by sharp increases in rents. Keep in mind the actual home prices are not included in the index, but are represented by what is known as owner's equivalent rent, i.e. what homeowners could get if they rented out their homes. Needless to say, the rising cost of renting homes is a direct byproduct of the weak housing market, as households are shifting from owning to renting.

However, that shift is planting the seeds for a reversal in rental costs. At some point, the rise in rents will price many households out of the market or at least encourage them to reassess the relative cost of purchasing a home versus renting. Also rising rents bring developers back into play, lured by the increased profit potential of constructing new multi-family dwellings. That process is well underway; multi-family housing starts in September and October hit the highest level in more than three years, double the average pace for 2010. In time, the current tight rental vacancy rate will ease up and cap the climb in rents. That dynamic may already be underway. In November, the increase in both owners' equivalent rent and actual rents paid on primary residences slowed considerably relative to past months. Not surprisingly, the Fed is assuming that the inflation measures will recede in the coming year.

To be sure, not all Federal Reserve officials subscribe to that view, and those with a more hawkish outlook may have restrained the Fed from pulling the trigger on more easing over the past year. But the Fed's policy-setting committee (the FOMC) is about to undergo its annual rotation of voting members, which could be a game changer in 2012. Of the four voting members that are about to be rotated out of the FOMC, three maintain hawkish views and have been generally resistant to an easier policy. Of the four entering voting members, three are perceived to be inflation doves who would be more inclined to favor greater monetary ease. So if conditions warrant it, Bernanke - long considered a growth advocate - would presumably receive more support for QE3 from the 12-member FOMC if he decides to pursue that line of action.

The question is whether conditions will warrant such a move. From our lens, the jury is still out. Clearly, the economy has established a more solid footing in recent months. But it's far from certain if the momentum can be sustained. Indeed, two key indicators released this week came in weaker than expected, suggesting that the year may not be ending on as much of a high note as perceived a few weeks ago. Retail sales, for example, posted a rather meager 0.2 percent increase in November and industrial production actually fell for the first time in seven months. Both measures were below market expectations and cast some doubt over the relatively muscular readings on consumer spending and factory activity reported over the past month. These include the headline-grabbing report that Black Friday sales were the strongest on record, raising hopes for a blockbuster holiday shopping season. Have consumers already shot their load?

It's still too early to arrive at conclusions, but our sense is that the November releases on retail sales and production have to be viewed with some skepticism. Parsing through the retail sales report reveals that at least some of the weakness was caused by the late October snowstorms in the Northeast that resulted in blackouts lasting through early November. That may have been why the weakest sales components are associated with outdoor activities, including driving (gasoline station sales declined) and dining out. Holiday-related sales, however, rang in reasonably well, as sales of electronics, general merchandise and clothing all rose, as did Internet sales, which clearly are not affected by the weather. What's more, the retail figures for September and October were revised up, so even with the disappointing November reading, consumers are on track to post a respectable spending increase in the fourth quarter.

Likewise, the slippage in industrial production may have been related to supply disruptions caused by the extreme flooding in Thailand during October. The supply cutoff, while not as extreme as that caused by the Japanese earthquake and tsunami in the spring, would have particularly affected the auto as well as the electronics industry, both of which dragged down the production index in November. We do not want to discount the possibility that the slowdown in Europe and emerging markets may be taking a toll on manufacturing. But a one-month setback is not enough evidence to support that notion. Moreover, the fact that the November slippage comes on the heels of a solid 0.7 percent gain in October and other regional measures of factory activity - including the New York and Philadelphia indexes - came in on the strong side lead us to suspect that the November IP reading was more of an aberration than a fundamental change in direction.

We continue to see the economic glass as half full instead of half empty, and believe the recent pickup in activity will extend through the end of the year. The European mess is surely a great threat and if it morphs into the apocalyptic vision that Ms Lagarde of the IMF foresees, all bets are off. Another potential threat is homegrown, reflecting the ongoing political squabbling in Washington. The two parties still haven't worked out their differences on extending the social security payroll tax cut and emergency unemployment benefits, or on a fix to prevent Medicare payments to doctors from being slashed in 2012. Leaders in both parties agree those things should be done, but the hang-up continues to be how and whether to fully offset the cost of those measures, which total more than $200 billion.

Democrats have dropped their proposal to pay for the extension of the payroll tax holiday with a surtax on incomes above $1.0 million. It's not clear what Republicans may give up in exchange. From some accounts we've read, House Speaker Boehner doesn't want to start negotiating with Democrats until the Senate votes on the bill that passed the House earlier this week. That vote looks like it will take place later today (Friday) or tomorrow. If the two parties can't compromise on extending the tax cut and other measures for a full year, Congressional leaders have a back-up plan, which would provide a two-month extension of the payroll tax cut, unemployment benefits, and presumably the Medicare "doc fix." The price tag for a two-month extension would be much smaller -- on the order of about $40 billion-compared to the $200 billion cost of a full-year extension. The good news is that a near-term drag on the economy would be avoided. The bad news is that we will be revisiting the debacle again in two months, with the potential knock-on effects on confidence and the financial markets. Stay tuned.

JPT121611-2070

Weekly Economic Commentary: Week of December 12

2011-12-12T11:29:00.000-05:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF DECEMBER 12, 2011

As the final chapter of the year unfolds, hardly anyone is expecting a blockbuster ending. At best, the economy should grow at a slightly faster pace in the fourth quarter than the 2.0 percent rate recorded in the third. At worst, some unpleasant shock will send bad vibes through the system, short-circuiting momentum heading into the new year. The most likely candidates for shocking news are well known, as they are dominating the headlines on a daily basis. Heading the list, of course, is the euro debt crisis, which seems to be in a permanent condition of flux. Despite an encouraging "fiscal pact" agreed to late Thursday, it was not the major breakthrough that the financial markets were hoping for; indeed, any sense of optimism was overshadowed by denials from the European Central Bank chief that it would intervene more aggressively in the sovereign debt markets.

Likewise, U.S. lawmakers are presenting an equally ambivalent front. Both Republicans and Democrats claim a willingness to extend the expiring Social Security payroll tax cut as well as benefits for the long-term unemployed. But they disagree over how to pay for the loss of revenues, with Democrats advocating a tax on the wealthy and Republicans seeking a reduction in spending. Odds are, political expediency will coax the two parties to reach some sort of a compromise before the end of the year. But it looks like the squabbling will continue until the week before Christmas. Congress was hoping to break for the holidays by the end of next week, but the legislators - with the urging of the administration - will probably have to keep deliberating beyond then.

Needless to say, any surprising development on either the European or domestic front would send the financial markets into a tizzy. Equally ominous is the knock-on effects on household and business confidence, which would not only abort a hoped-for Santa rally but also inject a harsh downbeat note into the economy as the curtain rings down on the year. Barring the worst-case scenario, however, it does appear that the second half of 2011 will end with neither a whimper nor a bang. This week's data, while sparse, support the modest-growth scenario portrayed by recent employment and spending trends for October and November. The Institute for Supply Management's index of nonmanufacturing activity, for example, slipped a bit in November to 50.0 from 52.9 in October. But that was just about offset by last week's reading on manufacturing, which rose from 50.8 to 52.7. Taken together, these gauges depict an economy that is squarely on a moderate growth path.

To be sure, it is tempting to extrapolate from the glowing shopping reports reported by retailers during the early days of the holiday season. While encouraging, it would be premature to assume that the recent pickup in consumer spending is sustainable. Simply put, there are still too many unanswered questions regarding the financial health and mindset of households. For one, the recession and financial crisis dealt a severe blow to balance sheets, and the healing process is far from complete. According to the Federal Reserve's latest flow of funds data, the process actually took a step back in the third quarter, thanks to continued declines in home values and a market downturn that erased more than $2 trillion from stock portfolios.

That drag on asset values more than offset a $600 billion decline in debt, wiping out $2.4 trillion in household net worth during the third quarter. At the end of the period, total assets exceeded liabilities by $57.4 trillion, down from $59.8 trillion at the end of June. Net worth peaked out at $66. 4 trillion just prior to the recession in late 2007 before dwindling to a low of $50.4 trillion in early 2009. The good news is that about three-quarters of the setback in the third quarter associated with the stock market nosedive has been recouped so far in the fourth quarter. If stock prices rise by another 5 percent or so before the end of the year, equity portfolios in the aggregate will be restored to mid-year levels. That's easily within reach of a Santa rally if one were to materialize. Keep in mind that the third-quarter stock-market correction came amidst a grueling debt-ceiling battle in Congress as well as the eruption of the sovereign debt crisis. The bad news is that neither the euro crisis nor the fiscal squabbling has been resolved, so a Santa rally remains hostage to uncertain developments on those fronts.

What's more, it is unclear when the housing market will hit bottom. In the third quarter, the value of household real estate fell by another $98.3 billion, more than offsetting a $53.7 billion drop in household mortgage debt. Since reaching a peak in the fourth quarter of 2006, housing values have plunged by $6.6 trillion, wiping out a considerable amount of real estate equity held by households. At the end of September homeowners saw the equity stake in their homes shrink to 38.7 percent. That's little changed from the second quarter and up a tad from the all-time low of 37.2 percent reached in the first quarter of 2000. But as recently as 2002, the equity share of owners was above 60 percent. Keep in mind too that nearly a third of all homeowners have no mortgage debt, so the remaining 50 million or so of households with outstanding debt have considerably less collectively than a 38.7 percent equity stake in their properties.

While the housing market continues to sag - the home price index compiled by CoreLogic, which the Fed uses in its calculation of housing values, slipped again in October - the major downside influence is coming from distressed properties. Prices of homes that exclude distressed sales have started to firm up and actually increased in October, a promising sign that the housing market is finding a bottom. Interestingly, not all of the $6.6 trillion decline in household real estate values can be attributed to falling prices. Some, if not much, of it also reflects the fact that fewer households own real estate, a natural fall-out from the recession and restrictive conditions in the mortgage market. In the third quarter, the homeownership rate stood at 66.3 percent, down significantly from the 69.2 percent peak reached in 2004. On a positive note, the ownership rate in the third quarter was higher than the 65.9 percent in the second quarter, another sign that housing conditions may be turning the corner.

Hardly any industry analyst expects housing to stage a breathtaking comeback in 2012, but a consensus is forming that the bottom should be reached sometime during the year. That's significant because the moribund housing sector has been a major albatross around the economy's neck since the end of the recession. Virtually every postwar recovery has been paced by a muscular rebound in housing activity and its absence during the current upturn goes a long way towards explaining the economy's subpar performance. More than 2 million construction jobs have been eliminated since the start of the recession in late 2007, nearly a third of the 6.3 million decline in nonfarm payrolls. That's an outsized contribution from an industry that accounts for less than 5 percent of total employment. Many, if not most, of those jobs will never return unless another housing bubble that generated so many construction jobs in the 2004-2006 period returns, an unlikely event in the foreseeable future.

Granted, some construction workers will find jobs in other industries as the economy expands and creates new opportunities. But the transition won't be easy without wide scale retraining efforts; even then the new positions will likely pay less than what the hardhats earned on construction sites. Still in a fluid economy with a flexible workforce, this shift is a natural byproduct of the "creative destruction" process that the economist Joseph Shumpter famously created in describing how capitalism works. The key of course is to get the economy growing at a fast enough pace that enables new industries to flourish and older ones to expand, thus sopping up construction as well as the millions of other displaced workers flooding the unemployment rolls. That's a daunting task considering the prevailing modest economic outlook held by the consensus of economists.

By now, most economists - and policymakers - are resigned to a prolonged period of high unemployment, as the major growth drivers are still not firing on all cylinders. As noted, households are still striving to repair balance sheets, which came under further duress in the third quarter. While the stock market has recovered most of its summer losses, home prices are still sagging and household budgets are coping with too much debt and too little savings. Indeed, one concern over the surprising strength in consumer spending is that it is coming at the expense of savings, something that is clearly not sustainable in the absence of stronger income growth. Another wild card is how households are viewing their debt loads. After three years of paying down debt, consumers are now starting to become more receptive to leverage again. Even credit cards are finding favor.

Since May, for example, outstanding revolving credit - mainly credit cards - has increased by more than $2 billion. The increase has been erratic, but the trend is a marked departure from the uninterrupted debt paydowns, totaling $18.2 billion, that took place from October 2008 through April of this year. The reversal is somewhat of a mixed blessing. On the positive side, it means that banks and other lenders are finally relaxing their tightfisted approach to consumer lending that has been in effect since the financial crisis. Although households have clearly reduced their demand for loans in recent years, the difficulty of obtaining credit has also been an impediment to spending as well.

On the negative side, however, the increased use of consumer credit in recent months may simply reflect an attempt by households to maintain living standards in the face of sluggish income growth. If that's the case, the recent spending resilience may be followed by a retrenchment in coming months when consumers choose to repay loans as part of their balance-sheet repair effort. That drag on economic activity would be reinforced if households also decide to restore the savings rate, which has declined from 5.0 percent to 3.5 percent over the past five months. The jury is still out as to how credit enters into the consumer spending equation as 2011 draws to a close. While more borrowing would seem to be a negative for the outlook, we are encouraged by the stronger showing in the labor market as well as the improvement in consumer confidence in recent months. That suggests households feel more optimistic about handling a higher debt load - and optimism has been a sorely lacking ingredient throughout the recovery.

JPT120911-2022

Weekly Economic Commentary: Week of December 5

2011-12-05T09:04:00.000-05:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF DECEMBER 5, 2011

We never look a gift horse in the mouth, so here's a heartfelt "thank you" to the Federal Reserve and its international cohorts for turning what looked to be a scrooge-like stock market trend into what may be the start of a Santa rally. To be sure, there's still plenty of time between now and Christmas for the elves and goblins to do their dirty work and short-circuit investor aspirations. But this week's decision by the Fed and other major central banks around the world to provide struggling European banks with access to cheaper dollar funds to finance operations was as bold as it was surprising. It remains to be seen if the substance of the deal lives up to the hype, but there's little question that its shock value carried a significant wallop - at least for a day. On Wednesday, the day the bombshell was dropped, world stock markets staged an eye-opening rally, including a more than 4 percent surge in American stock prices.

A 4 percent jump in market prices translates into about $1 trillion in paper wealth, so the day's event was nothing to sneeze about. Assuming the gain is not quickly erased - something that can't be dismissed in an era of extreme market volatility -- some of it will no doubt wind up in the spending stream, helping propel the economy forward. But as hinted above, the hoopla surrounding the coordinated action by the central banks may be more hype than substance. While it does relieve liquidity pressures of major European banks, at least temporarily, it does little to address the euro crisis. Weaker members of the euro zone are still struggling to finance their deficits, which is becoming even more difficult amidst weakening growth prospects that lower tax revenues. Meanwhile, investors are demanding ever-higher yields on sovereign debt, which heightens the risk of default and further strains the capital position of European banks holding that debt. Until and unless the leaders of the European community agree to tighter coordination of fiscal policies and establish a financial backstop large enough to prevent a default, the euro crisis will not simply melt away.

That said, the actions of the central banks do underscore the urgency of the problem and suggest that the message is getting through to the very top echelons of the EU. There were signs that some broader coordinated measures are being considered among the political elite, which may add substance to the hype. We'll see. Indeed, after Wednesday's rally investors turned more cautious over the remainder of the week and prices barely moved. Still, the day's huge gain was retained, propped up by further news on the economy that weighed in more on the positive than the negative side of the ledger. The news we are referring to concerns the top issue that is dominating the political debate heading into the 2012 elections: jobs. Republicans are lambasting the president for his policies that are allegedly responsible for the lack of job creation. The president and his Democratic colleagues are firing back, asserting the Republicans are obstructionists as they are preventing job-creating legislative action under the banner of fiscal austerity.

The debate will only intensify in coming days as the deadline for extending the temporary payroll tax reduction and emergency unemployment benefits draws closer. We suspect both will be extended and perhaps the payroll tax cuts expanded, although just how the lost revenues will be financed - if at all - remains uncertain. Meanwhile, the political debate will revolve over incoming data on the jobs front, with Republicans drawing strength from weaker numbers and Democrats becoming emboldened by stronger reports. So how does the latest jobs report weigh in? On the surface, both parties can claim victory of sorts. In November, the economy generated 120 thousand net new jobs - decent but still weak - and worker pay and hours worked actually declined during the month, weighing in on the negative side of the ledger.

From our lens, however, the positive elements of the report outweighed the negative. True, the 120 thousand increase in nonfarm payrolls (140 thousand in the private sector offset by a 20 thousand reduction in government jobs) just barely keeps up with population growth. But the Labor Department revised up the increase for both September and October by a cumulative 72 thousand jobs, lifting the September gain to a solid 210 thousand. This is the fourth consecutive report that revised the estimate for previous months higher, which is a strong sign of an improving job market. At the very least, the cumulative revision together with the modest initial estimate for the latest month is proof positive that we are moving in the right direction. It would be nice to be moving a bit faster, but the consistency of recent payroll gains suggests that the upward trend is legitimate.

The payroll gains were reasonably widespread, but retail establishments stepped up their hiring in a big way in November. Retailers took on 49.8 thousand new workers during the month, up from 12.7 thousand in October, which is consistent with reports of a strong holiday shopping season. It's also consistent with the upward revisions to prior months, which are portraying a stronger job market than the original estimates suggest. Indeed, the surprising resilience in consumer spending since the late summer may well reflect a more robust job market than is generally perceived. Nonetheless, it's probably premature to read too much into the muscular increase in hiring by retail establishments. Keep in mind that the Thanksgiving holiday season started one day earlier than usual this year, which means that merchants may have started hiring earlier than usual. If so, they will be taking on a less than seasonal number of workers in December, which could result in a disappointing jobs report for that month.

But it is the companion household survey of labor market conditions, which generates the unemployment rate, that provided the real upside surprises this month. For one, the headline-grabbing unemployment rate plunged from 9.0 percent to 8.6 percent in November. That's a particularly sharp one-month drop in a rate that the consensus of economists thought would remain stuck at the 9 percent level. Unlike the payroll data, derived from a survey of business establishments, the unemployment figures are usually not revised. What's more, the pattern during the current recovery is that big drops in the unemployment rate, which have occurred three times since the recession ended in mid 2009, tend to stick or lead to further declines. For example, the last time the rate fell by 0.4 percent, from 9.8 percent to 9.4 percent last December, another drop to 9.0 percent took place the next month, where it more or less remained throughout the next ten months.

To be sure, the big slide reported in the jobless rate comes with a healthy dose of skepticism. Critics point out that the drop was accompanied by an outsized 314 thousand reduction in the size of the labor force, which lowered the labor force participation rate from 64.2 percent to 64.0 percent, near the lowest since the early 1980s. True, but there was also an even bigger 593 thousand decline in unemployed workers. Hence, that means 279 thousand workers found jobs, which is far greater than the 120 thousand increase in nonfarm payrolls reported in the establishment survey. This discrepancy between the establishment and household surveys has persisted for several months, with 1.28 million households reporting that they have found jobs over the past four months versus only 534 thousand reported by businesses.

There is no clear explanation for this, but the two measures tend to converge over a period of six months or so. It may well be that the payroll canvas is not picking up all the jobs created by new firms established during the survey period. That's not unusual during a recovery, when the Labor Department's "birth/death model" tends to underestimate new business formations. We suspect that the stronger gains seen in the household survey are more indicative of labor market trends than what's shown by the payroll survey. One reason for this belief, aside from the surprising resilience in consumer spending, is the assertion by households in recent consumer confidence surveys that jobs are becoming easier to get. For example, in the November survey taken by the Conference Board respondents reporting that jobs are "hard to get" fell to the lowest level since January 2009, while those reporting that jobs are "plentiful" rose to the highest level since May 2009. Whether or not the hard data supports the survey, perception does count, which may also partially explain why consumers are spending more than expected.

Still, the sizable drop in the labor force during the month does support the notion that the sharp drop in the unemployment rate exaggerates the improvement in employment conditions. Had the labor force participation rate remained at 64.2 percent, the jobless rate would have fallen only half as much. Meanwhile, the broader unemployment rate, known as U-6, fell by an even steeper 0.6 percent, from 16.2 percent to 15.6 percent. This measure includes so-called "marginally attached workers" to the labor force, those who are too discouraged to look for a job but would like one, as well as part-timers who would prefer full-time positions. The drop in this rate reflects primarily a huge 378 thousand fall in part time positions, which means that these workers either found full-time jobs or had their hours expanded to a full-time schedule. Either one is a positive thing, in our view.

So what is the main takeaway from the latest jobs report? Our overall impression is that it was a decent, but not great reading of unfolding labor market trends. Employment growth continues to show modest and steady improvement, but the pace remains too slow to sop up the huge pool of unemployed workers, which remains at an intolerable 13.3 million. Of that total, 5.7 million have been out of a job for 27 weeks or longer and the average length of unemployment rose to 40.9 weeks from 39.4 weeks in October. The plight of the long-term unemployed remains as dire as ever and the longer it persists, the more it increases the likelihood that a high structural unemployment rate will be embedded in the labor force. That's because the longer a worker remains unemployed, the harder it is to be hired as skills erode and prospective employers attach a stigma to these hard-luck job seekers.

Nonetheless, we are mildly encouraged by the latest job numbers, particularly those contained in the household survey. If the persistent upward revisions to previous months payroll figures is any indication, the improvement in the job market is gaining traction and so too, by extension, is the overall economy. The only downbeat note is that worker pay remains stagnant, which is not surprising when there is so much surplus labor competing for available jobs. But let's fix one thing at a time. If the pace of job creation continues to improve, pay raises will follow in time. When the two gauges of labor income move in lockstep, the stage will be set for a sustained and more robust pace of economic growth. But that stage is still a hope, not a reality, which sadly remains a hostage to uncertain geopolitical forces that are far from being resolved.

JPT120211-1984

Weekly Economic Commentary: Week of November 28

2011-11-28T10:56:00.000-05:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF NOVEMBER 28, 2011

The week may have been shortened by the Thanksgiving holiday, but it clearly feasted on a multitude of events. As has been the case for the past several weeks, the main event happened overseas with the European debt crisis ratcheting up another notch and sending global stock prices, including in the U.S., into a tailspin. Government and finance leaders on the Continent continue to exhibit a total lack of leadership, staying one step behind an unfolding debt crisis that seems to be escalating by the day, if not hour. Perhaps the most pronounced incident this week was the failed auction of German bonds, considered the bulwark security in the region against which other sovereign yields are compared to assess risk. Despite its rock-solid status, more than one-third of the bond auction failed to attract buyers, which is a huge blow to the prestige of Germany, long considered to be strongest in the region. With this erstwhile safe haven coming under attack, there is understandably growing concern over whether the European leaders have the will or the ability to keep the euro-currency union from crumbling before long.

To be sure, trading tends to be very light in a holiday-shortened week, which results in unusually volatile price swings. We'll have a better sense of market sentiment when traders and investors resume their full schedule this week, which will no doubt absorb some more news on the euro front. That said, there was plenty of news on the domestic front to digest, although the data did not offer a much clearer picture of where the economy is heading. On the surface, some appeared to be unexpectedly downbeat. The first estimate of the economy's growth rate, for example, was revised down sharply, leaving the impression that activity was considerably weaker over the summer months than had been perceived. Instead of increasing at a 2.5 percent rate, the government's revised figures put the growth rate of real GDP at 2.0 percent during the third quarter. That's still better than the 0.4 percent and 1.3 percent growth rates posted in the first and second quarters, respectively, but well below what is needed to reduce the intolerably high unemployment rate.

But as they say, the devil is in the details, and in this case the downward revisions do not alter the economy's forward momentum. Virtually all of the adjustment was due to a correction in the estimate of inventories, which now show a decline of $8.5 billion rather than an increase of $5.4 billion. The inventory drawdown in the third quarter took a 1.55 percentage point bite out of the economy's growth rate, about half-percentage point more than the first estimate. There was a slight downward revision to real consumer spending, which still posted a respectable 2.3 percent increase during the period. Significantly, real final sales of domestic product, which excludes inventory changes, increased by a solid unrevised 3.6 percent, up from 0.8 percent over the first half of the year and 1.4 percent for all of 2010.

It's unclear why businesses kept inventories so lean during the period. It could be that purchasing managers turned very cautious in the face of all of the uncertainties associated with the European debt crisis and the political shenanigans in the U.S., including the summer's debt-ceiling debacle. Or it could simply reflect an underestimate on the part of business leaders of the strength in final sales, which had to be met out of existing stocks. In any event, the inventory depletion means that orders and production should rise to the level of actual and anticipated sales in the fourth quarter, something that will add vigor to the economy's momentum during the period. That said, it would be a mistake to expect a major inventory-led spurt in growth. Businesses are not likely to stockpile more goods than is necessary to accommodate expected sales, and the outlook for final demand is anything but ebullient.

Yes, consumers are showing a hefty appetite for the new iPhones and Kindle E-Readers, and the usual media hoopla about shoppers lining up at midnight on Black Friday suggests a blockbuster holiday buying season. But consumer demand remains very much a wild card amidst high unemployment, stagnant incomes, high debt loads and falling home values. Indeed, the October report on personal income and spending, released this week, paints a mixed picture of how consumers are starting off the fourth quarter. As is the case with the GDP report, the headline story is not very encouraging. Total outlays on goods and services edged up by a barely perceptible 0.1 percent during the month, a much smaller increase than expected given the more upbeat report on retail sales released last week. But retail sales do not include spending on services, which turned out to be hugely disappointing in October. The 0.1 percent increase in overall consumption was the smallest in four months and pales in comparison to the robust 0.7 percent gain posted in September.

But the underlying details reveal a somewhat brighter picture. For one, even the skimpy 0.1 percent increase builds on the sturdy gain in September, leaving the level of total consumption solidly higher than the average for the third quarter. Hence, the forward momentum remains intact. Indeed, real personal consumption stood 1.7 percent above the July-September average, which would be the growth rate for the quarter if no further gains were posted in November and December. But there is every reason to expect real consumption to at least match if not exceed the third-quarter's 2.3 percent growth rate. One reason: the income side of the ledger showed considerable improvement. Total personal income increased by a solid 0.4 percent, which was stronger than expected and the biggest increase in eight months. What's more, most of the increase came from wages and salaries, which increased by a robust 0.5 percent following a 0.4 percent gain in September.

The pickup in wages and salaries is significant because labor income has a more sustained influence on spending and suggests that worker paychecks are finally drawing strength from an improving job market. Keep in mind that the third-quarter rebound in real personal consumption was greeted with a good deal of skepticism, largely due to its shaky underpinnings. During the period, disposable incomes edged up by a puny 0.2 percent, the slowest quarterly rate since the end of the recession, and actually declined by 2.1 percent after adjusting for inflation. That means consumers financed their increased spending by saving less, a practice that cannot be sustained for long. In recent years, households have gone to great lengths to rebuild balance sheets that were greatly damaged by the financial crisis and housing meltdown. As part of that effort, the savings rate, which had fallen to near zero at one point in 2006, was restored to over 6 percent during the recession and generally remained above 5 percent during the first two years of the recovery.

But from a nearby high of 5.2 percent, the savings rate started to be drawn down, hitting 3.3 percent in September. With balance sheets still not fully repaired, a savings rate that low threatened to curtail spending, raising the prospect that a promising holiday shopping season would be followed by a bust. That's why the solid increase in income in October is so welcomed. Indeed, with incomes rising more than consumption during the month, the personal savings rate actually moved up, rising to 3.5 percent - still low but moving in the right direction. The question is, will efforts to reestablish a more comfortable savings rate lead to the aforementioned bust in spending as the curtain rises in 2012? That question can't be answered until we know how strongly income increases. Clearly, strong increases would enable households to both sustain modest gains in spending as well as put aside more in savings.

It's worth noting that the rise in worker paychecks was accompanied by a decline in prices during October, a combination that fueled a solid increase in household purchasing power. Indeed, real disposable incomes increased by 0.3 percent during the month, the first increase in four months that also equaled the strongest monthly gain since May 2010. One month does not make a trend, but recent signs of an improving labor market certainly augur for fatter paychecks in the months ahead. That said, we are also mindful of the possible obstacles that could undermine the potential boost to household purchasing power in the immediate future. Perhaps the most pronounced land mine is being dug by no other than Washington itself.

What we are referring to is the $150 billion in purchasing power that would be wiped out if Congress does not renew a number of key provisions of the 2010 tax law that are set to expire at the end of 2011. The most important are the temporary Social Security payroll tax cut and the emergency unemployment benefits for the long-term jobless. Allowing those two provisions to expire means that workers and the unemployed would have $150 billion less to spend (or save) in 2012 compared to this year. That alone could shave more than a full percentage point from the economy's growth rate, making the recovery highly vulnerable to any external shock. We suspect that not even the acrimonious divide between the Democrats and Republicans that scuttled the deficit-reduction Super-committee last week will prevent Congress from extending those provisions. But when it comes to politics, anything can happen so it's wise not to take anything for granted.

Even if the provisions do get renewed, the economy will not be completely out of the woods. Most economists agree that until the moribund housing industry regains its footing, the recovery will lack the critical support necessary to sustain its momentum. Since 1970, real residential outlays have accounted for about 20 percent of GDP growth during the first two years of an upturn, far greater than the 5.7 percent average share such spending has had in the overall economy. The absence of that cyclical thrust this time is a key reason the recovery has lagged past upturns to such a great extent. On the positive side, housing seems to have hit bottom and is no longer a major drag on growth. Unfortunately, a meaningful rebound is nowhere in sight, thanks to the overhang of homes in foreclosure and an unreceptive mortgage market.

Indeed, the latest report on home sales highlights a particularly troubling trend that may be stifling a housing recovery. Existing home sales did edge up in October, increasing to 4.97 million units from 4.90 million in September. That's the good news. The bad news is that during the month fully one-third of all contracts to purchase an existing home were cancelled, up from 18 percent in September and 8 percent a year ago. A cancellation can be triggered by a number of factors, but one common reason is that the lender denies a mortgage application because it appraises the underlying home at less than the negotiated price. This is just one example of the tighter lending standards that are impeding a housing recovery, which is one of the more intractable problems facing policy makers. Until it is fixed the recovery is likely to remain on a ho-hum path, waiting for this important growth driver to finally kick in.

JPT112511-1920

Weekly Economic Commentary: Week of November 21

2011-11-21T09:21:00.000-05:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 21, 2011

There has been a wide variety of adjectives to describe the economy's performance over the past two years: sluggish, vulnerable, resilient, erratic, to name a few. But one that is not so obvious and rarely discussed is the paradoxical nature of the recovery. While there are many examples to cite, the data released this week provide a striking illustration of this observation. Take the auto industry. Recall that the administration received a good deal of criticism when it bailed out two of the three major car companies during the depths of the recession. But not only has the government made a profit on the venture, a good case can be made that the auto industry is now bailing out the U.S. economy.

Another paradox is the easing of inflation that spiked earlier this year, thanks to sliding prices of gasoline and many commodities that ignited the earlier surge. Economists generally ascribe this reversal to weaker global demand for oil and commodities, which clearly has a negative connotation. But falling inflation also increases purchasing power, which boosts demand and is clearly a positive development. Perhaps the most dominant paradox since the recession ended derives from the persistent deleveraging trend among households. Reducing debt, of course, is a necessary condition to put households on the road to financial health - a positive long-run development - but it also results in less consumption, which acts as a drag on growth in the short run.

These are only a few of the paradoxical themes that underpin the tortuous road the recovery has traveled so far. The fact that the recovery has been sustained despite its inherent incongruities - not to mention the powerful external headwinds that continue to impede its progress - indicates that the good has outweighed the bad. How long this can continue in the face of potential obstacles remains to be seen. Two dangerous potholes in the recovery road are practically upon us. The so-called congressional supercommittee is quickly approaching the November 23 deadline for reporting legislation that would reduce the deficit by $1.2 trillion. Failure to cobble together a package of revenue increases and spending reductions could further undermine the already shaky confidence of households and businesses and heighten financial market volatility. Given the hugely polarized positions of Democrats and Republicans on the committee, this worst-case scenario cannot be ruled out.

Then there is the ongoing - and seemingly intractable -- European debt debacle that has been the most influential force on the markets in recent weeks. Stock prices are moving inversely with changes in yields on Italian and, now, Spanish sovereign debt, declining as their yields pierce the psychologically important 7 percent threshold, and rising when those yields recede below that level. Lately, France has been dragged into the cauldron of worries, as the threat of a rating downgrade and the vulnerability of French banks to sovereign debt markdowns have pushed up the yield on French government debt. The yield has not approached the levels of Italy and Spain, but its spread relative to bulwark German bonds has increased to the widest point since the euro was established in 1999. A major sticking point among European leaders is deciding what role the European Central Bank should play to staunch the debt crisis. The weaker nations want the ECB to purchase as much government debt as necessary to keep yields down, while the stronger ones - most notably Germany - are steadfastly opposed to opening up the money-printing presses and the inflationary consequences that would materialize.

We should have some answers on the fate of the supercommittee fairly soon; from our lens, the most likely outcome is that it kicks the can down the road by slapping together some less-than-pungent measures, which will not make much of a dent in the long-term budget problem. However, it may calm the markets' nerves for the time being. As for the euro crisis, well that cloud is not likely to dissolve any time soon, as government officials seem to be as intractable in their positions as are the Democrats and Republicans in the U.S. The only question, from our lens, is whether the U.S. economy can withstand the inevitable shock that would ensue if the euro zone crisis becomes a Lehman-like event, precipitating another global market meltdown. Since we are genetically embedded in the optimistic camp, our sense is that a less-than-satisfactory solution will be found, neither healing the euro woes nor throwing the Continent into a deep recession. If this muddle-along scenario plays out, the positive elements underscoring the U.S. recovery should continue to outweigh the negatives, sustaining moderate growth throughout the remainder of the year.

Still, it is hard to ignore the paradoxes that shone through in this week's batch of economic indicators. While it may be a stretch to claim that the auto industry is returning the government's favor by bailing out the economy, it clearly is doing some heavy lifting. According to the Federal Reserve's latest industrial production report, the nation's factories, utilities and mines increased output by a solid 0.7 percent in October, following a slight decline in September that was weighed down by a drop in utility usage. Manufacturing, the biggest component, posted a 0.5 percent gain, the fourth consecutive month of sturdy increases. The higher output was broadly distributed among major industry groups, including business equipment and consumer goods. That's a good sign that capital outlays remain strong and retailers are stepping up orders to replenish inventories, which may have been depleted by resilient consumer spending.

But the major thrust behind the overall output gain came from the auto sector. Production of motor vehicles and parts jumped by 3.1 percent during the month, lifting the annual gain to 8.9 percent. True, the auto industry is striving to regain output lost due to parts shortages that followed the Japanese earthquake last March. In the April-June period, auto output plunged by a 15.1 percent annual rate. But that was sandwiched between a heady 29.1 percent increase in the first quarter and a 21.1 percent rebound in the July-September period. With the 3.1 percent gain in October, the fourth quarter is shaping up to be even stronger. Hence, even allowing for the second-quarter plunge, the auto sector is on track to turn out 8.43 million vehicles this year, which would be 9 percent greater than in 2010 and a whopping 47 percent larger than the depressed 5.72 million produced in 2009.

How important has this been for the economy? Consider that the value of automotive products accounts for less than 10 percent of the gross value of all industrial products and nonindustrial supplies produced in the U.S. Yet, since mid-year the auto sector has contributed more than one-half or $33.3 billion to the $60.1 billion increase in the value of total output, adjusted for inflation. Simply put, the auto companies have done more than their fair share of keeping the economy afloat this year. What's more, auto inventories, at 1.91 months of sales, remain lean, even as households are snapping up new cars at a rapid rate. More than 13.2 million light vehicles were sold in October, the fastest selling rate since February and up from 13.05 million in September.

If only the other beleaguered, relatively small, sector of the economy - housing - were recovering from its slump as well as autos, the economy would be in much better shape. Sadly, the housing industry is not faring nearly as well, as its struggles continue to capture headlines as well as much of the blame for the economy's lackluster performance over the past two years. But even here, signs of progress can be seen. Housing starts slipped a tad in October, due entirely to a decline in the volatile multisector sector. But the overall drop was much less severe than expected, and construction for single-family homes posted a solid 3.9 percent gain, the first increase since June. What's more, building permits surged by about 11 percent during the month, reaching the highest level since March 2010.

To be sure, much of the nascent strength in homebuilding is in multifamily construction, where starts are running 50 percent ahead of last year's pace and permits stood 48 percent higher in October than the corresponding month in 2010. That's not surprising given the strong demand for rental units that has driven down vacancies and pushed up rents, making apartment construction a profitable endeavor for developers. Given the tighter lending conditions for mortgages and the continued onslaught of foreclosures, the shift away from home purchases should continue to underpin strong demand for apartments over the foreseeable future. But the tide may soon be turning as the increase in rents and sharp decline in home values may be prodding would-be homebuyers into reconsidering the relative merits of owning versus renting. Moreover, the inventory of unsold single-family homes on the market is the lowest in more than fifty years, so even a modest uptick in demand could well spur builders to ramp up construction quickly.

At the very least, homebuilding is no longer dragging down the economy, even as other sectors are regaining their footing. The elephant in the economic room, of course, is the consumer, and the signs continue to flash more positive than negative. Real consumption increased by a respectable 2.4 percent annual rate in the third quarter, and there is every chance that it will match if not exceed that pace in the current quarter. As reported this week, retail sales posted a decent 0.5 percent increase in October, beating market expectations of a 0.3 percent gain. Those new iPhones helped drive sales, but consumers spread their dollars around a broad range of products, including electronics, food and beverages and sporting goods. Sales of apparel slipped by 0.7 percent during the months, but that followed a strong 1.7 percent gain in September, so seasonal issues with back-to-school spending may be at fault.

What's more, the retail sales increase occurred despite a drop in gasoline sales, reflecting lower prices at the pump. Excluding the price-driven gasoline and volatile auto sales, retailers rang up a healthy 0.7 percent increase in sales, the strongest increase since March. The continued resilience of consumers is one of the more surprising aspects of the economy's performance since the spring/summer slump and underscores the growing expectation that the recovery will retain momentum of the final months of the year. We concur with the assessment, but are mindful of another paradox that could come back to haunt us. With sales rising faster than incomes, it seems that consumers are financing their purchases by saving less. In the short-run, that's good for the economy. But if incomes continue to lag and job prospects do not improve, households could rethink that behavior and decide to save more. While that may be good for individual families, the paradox of thrift says that if everyone decides to put aside more savings, they will collectively wind up suffering because the economy would be weaker. Just another conundrum to ponder.

JPT111811-1895

Weekly Economic Commentary: Week of November 14

2011-11-14T08:42:00.000-05:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 14, 2011

There is usually a hiatus of a week or so between the time the all-important jobs report is released on the first Friday of the month and the blizzard of data that comes afterward, which fleshes out important details of the economy's performance. Since this brief period is devoid of significant economic news, one would think it would also be characterized by relative calm and introspection. If only that were the case. As the market turbulence this week strikingly illustrates, the luxury of complacency, however brief, has no place in a global economy that is constantly buffeted by unexpected developments. This week was no exception.

To be sure, the domestic economy had little to do with the wide gyrations in stock prices this week. For the most part, the positive tone sounded by last week's jobs report remained very much intact; indeed, it was even reinforced by a handful of newly released indicators. What investors responded to during the week was another eruption from the ever-evolving Greek drama, which embraced Italy and threatened to tear asunder the euro zone. The yield on Italian bonds soared above 7 percent at one point, a psychological threshold that forced other member EU nations to seek bailout funds in the past and sent the Dow Jones industrials to tumble by 400 points on Wednesday. It also facilitated the exit of Prime Minister Berlusconi who is joining his Greek counterpart Popendreau off the government payroll.

But just as the travails in Europe neared a crisis point, a semblance of order returned as the reformulated governments of the two beleaguered nations promised to take appropriate measures to address the problems responsible for their pariah status in the eyes of the EU. Stocks rebounded on Thursday and Friday, sending share prices modestly higher for the week. Few observers, however, believe that the unfolding drama is heading for a happy ending. When the next shoe will drop is anyone's guess, but it's clear that the so-called troika of European leaders - the European Union, the IMF and the ECB - is consistently one step behind every mini crisis that erupts. A monetary union that lacks the fiscal authority to impose unified principles on sovereign nations is a recipe for systemic problems that will not go away.

Nonetheless, the promised reforms at least eased the tension underscoring the market's turbulence, even as economic conditions worsened. Increasingly, it looks like Europe is on the doorstep of another recession, as growth in Germany, France and Britain has downshifted abruptly and policymakers are more inclined to ride the fiscal austerity bandwagon than inject stimulus into their economies. Not too long ago, the U.S. was in the same boat, flirting with a double-dip recession even as political gridlock prevented fiscal action and the Federal Reserve faced a mounting backlash towards its unconventional approach to reviving growth. But unlike Europe, the U.S. economy is displaying more resilience than thought possible a few months ago. Not only did growth speed up markedly in the third quarter compared to the first half of the year, the labor market is showing increasing signs of life that may sustain momentum over the closing months of the 2011.

The October jobs report released last week contained too many mixed signals for the optimists to declare victory, but there is little question that the details were encouraging. What's more, the Labor Department provided two more reasons for optimism this week. First, the weekly report on first-time unemployment claims revealed a drop to the lowest level in eight months, falling below the 400 thousand threshold to 390 thousand in the November 5 week. These figures say more about layoffs than hiring, but historically a number below 400 thousand is associated with respectable gains in job creation. A few more weeks that show a shrinking number of applicants for unemployment benefits could be a compelling sign of improving job prospects.

Second, the Labor Department also released another set of figures that provide a more detailed look into the employment numbers. Keep in mind that the monthly jobs report is basically a snapshot of net changes in jobs and payrolls without providing details on how those changes came about. That void is filled by the so-called JOLTS report, standing for job openings and labor turnover, which is released with a one-month lag. Higher turnover usually depicts a strengthening job market because it it indicates that employers are more willing to make decisions regarding staffing needs. While the decline in layoffs, as manifested by the fall in unemployment claims, is surely a positive development, a more decisive boost to job prospects occurs when hiring is also increasing. The latest JOLTS report strongly suggests that is underway.

In September, companies posted 3.35 million job openings, the highest number since August 2008. Recall, that's the month of the Lehman Brothers collapse, which ignited the financial crisis that turned a garden-variety recession into the Great Recession. By itself, the greater number of openings is good news for the army of unemployed searching for a job. Indeed, the increase lowered the ratio of unemployed workers to job openings to 4.2 from 4.5 the previous month. That is still more than double the average ratio of job seekers to openings that prevailed during the expansion years prior to the Lehman collapse, but it is down significantly from the 6.9 ratio in July 2009.

What's is also encouraging is that the number of workers voluntarily quitting their jobs is on the rise. In September, quits rose to the highest level since November 2008, posting the third consecutive monthly increase. The significance of this is that it indicates workers are feeling more secure about finding another job, no doubt encouraged by the increase in job openings. Additionally, when a worker quits a job, it opens the door for an unemployed worker to fill a position - a win-win for all concerned. To be sure, all this enhanced turnover has to be supported by actual hiring or else it amounts to little. Happily, hiring also increased in September, rising to the highest level since last May. Sadly, though, it is not keeping pace with the increase in job openings. So far the year, job openings are up 22 percent while hiring has increased by only 12 percent. It is hard to interpret that discrepancy. Some believe that employers are not fully committed to filling their posted openings, waiting to see how the economy holds up. Others believe that companies are having trouble finding qualified workers, reflecting either a lack of available skills or the inability of workers to move to a new location because of the moribund housing market.

Whatever the case, nothing gives more of a boost to consumer confidence than improved job prospects, and the aforementioned positive signs appear to be having an uplifting effect on household psychology. On Friday morning, the Reuters/University of Michigan released its preliminary reading on consumer sentiment for early November, showing an increase in the sentiment index to 64.2 from 60.9 in October. That's a stronger showing than expected, and underpins the surprising resilience in consumer spending in recent months. But as the chart shows, households are hardly in a joyous mood. What the recent strength suggests is that the deep plunge in sentiment that took place over the summer was largely event-driven, highlighted by crippling oil prices, the debt-ceiling debacle and rating downgrade of Treasury securities. As those events receded into the background, household spirits perked up. Still, sentiment has only partially recovered and remains not far from the lows reached during the recession.

Clearly, more good news on the labor front would go a long ways towards brightening the mood of households, not to mention their actual spending behavior. Another positive catalyst, of course, would be a rebound in the housing market, which continues to be a dead weight on the economy. But even in this long-depressed sector, signs of stability are emerging. Admittedly, the road to recovery is steep and still elusive, as sales are being hampered by tight mortgage conditions, a huge overhang of foreclosed properties and steep price declines that are keeping prospective buyers on the sidelines, expecting further declines. This week, one of the three major organizations tracking home prices, CoreLogic (the others being S&P/ Case-Shiller and the Federal Housing Finance Agency) released its latest finding for September. As expected, home prices slid, falling 1.1 percent following a 0.3 percent drop in August. These prices are not seasonally adjusted, so the declines are not surprising as we move further away from the spring and summer selling season.

But there is a silver lining that is starting to shine through an otherwise dismal housing picture. Essentially, the weakness in home prices is being heavily influenced by distressed sales, the 30 percent of housing transactions that consists of foreclosed properties or short sales that come with deeply discounted prices. If those transactions are excluded, the housing picture takes on a brighter hue. As the chart shows, prices of conventionally-sold properties (i.e. excluding foreclosures or short sales) rose by 0.3 percent, following a 0.1 percent increase in September. That marked the sixth consecutive monthly price increase for homes that are not being sold under duress. While similar increases were observed in the spring of 2009 and 2010, recall that tax credits played an important role boosting sales during those periods. The current rebound in prices is not benefiting from such artificial props, which is a hopeful sign.

The bad news is that distressed sales are not going away. According to the National Association of Realtors, distressed sales accounted for 30 percent of transactions in September, with foreclosures accounting for 18 percent and short sales 12 percent. To be sure, the 30 percent share of distressed sales is down from the levels seen during earlier points of the housing crisis - they accounted for 50 percent of sales in March 2009. But 30 percent is still very large historically. While the NAR didn't start monitoring distressed sales until March 2008, when they took an 18 percent share, anecdotal evidence suggests that such sales were in the low single-digits prior to the housing crisis. Needless to say, a full-fledged housing recovery will not be launched until the overhang of distressed borrowers is whittled down to acceptable levels, something that is proving to be an agonizing challenge for Washington.

JPT111111-1850

Weekly Economic Commentary: Week of November 7

2011-11-07T10:37:00.000-05:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 7, 2011

Just when it seemed the European debt crisis could be put on the backburner for a while, the Greek drama added another suspenseful chapter that is leaving analysts scratching their heads in disbelief. As the week drew to a close, it was still unclear if the bailout plan forged by European leaders last week would be put in place or upended by Greek politics. Whatever the outcome, one thing is clear: the twists and turns in the ongoing drama are having a magnified impact on the financial markets. The wide gyrations in stock prices over the past week reflect both the speed that markets respond to events and the extreme sensitivity of investors to unfolding developments. All we can say is keep your seatbelts fastened.

Meanwhile, the domestic scene is not exactly an island of tranquility. But compared to Europe, which seems to be on the cusp of recession, conditions here are considerably more promising. The much-feared double-dip scenario, so prevalent a month or so ago, has just about faded into obscurity thanks to a string of stronger-than-expected economic data. To be sure, the economy is still moving ahead at a lackluster pace and downside risks to the outlook are widely recognized. The Fed, for one, lowered its forecast for this year as well as for 2012 and 2013 and presented a grim picture for the job market. Among the many headwinds weighing heavily on the current as well as the near-term future, the moribund housing market and financial strains associated with the European debt crisis loom large.

The Fed presented its revised outlook following its two-day policy meeting this week. As expected, no action was taken at the meeting, as the recent improvement in economic activity was taken into consideration. In its policy statement, the Fed noted that "household spending has increased at a somewhat faster pace in recent months" and that "economic growth strengthened somewhat in the third quarter." But in light of the significant downside risks looming ahead and recognizing that the economy has underperformed relative to past forecasts, the Fed made a nod to reality and marked down its outlook significantly compared to its previous forecast. As the table shows, the economy is expected to grow more than 1 percentage point slower this year than was projected back in June, and the estimate for the unemployment rate was raised by about 0.3 percentage point. Similar markdowns were made for 2011 and 2012.

Simply put, the pace of activity envisioned by the Fed over the next few years means that economic resources will be underutilized for some time, extending what chairman Bernanke stated is the "frustratingly slow" decline in unemployment. It also indicates that policy will remain aggressively easy as long as inflation remains tame, which is the most likely case in a slowly growing economy with a huge amount of slack in the labor market. But with deflation no longer an imminent threat, the Fed will wait and see before embarking on another round of quantitative easing or other unconventional measure to stimulate growth. Still, those measures are on the table and Bernanke indicated that he would not hesitate to pull the trigger if the economy suffers another relapse. One of his pet concerns is that fiscal policy will turn overly restrictive as an unintended consequence of political gridlock. If there is any lesson to be learned from imposing fiscal austerity on weak economies, it is only necessary to look at what is happening in Europe.

That said, the Fed's 1.7 percent growth estimate for 2011 contained in its revised forecast implies a second-half growth rate of 2.5 percent, since the first half averaged only 0.8 percent. In other words, a modestly improving trend remains on track that, if sustained, should bolster confidence and become the catalyst that builds momentum going forward. The key, of course, is whether the steady improvement will light a fire under the labor market, which is essential to get the ball rolling. If recent employment data are any indication, the signs are promising. This Friday's jobs report for October is a good example of both the promise and the "frustratingly slow" progress cited by Bernanke.

Looking at the frustration first, the economy generated a mere 80 thousand nonfarm jobs last month, the smallest increase in four months and modestly below expectations of about a 100 thousand gain. It also fell far short of the 125-150 thousand monthly increase needed just to keep up with an expanding population and, hence, does nothing to relieve the glut of unemployed workers. The 80 thousand increase is a step back from the 130 thousand average monthly gain during the third quarter. Since October marks the first month of the fourth quarter, it raises the question of whether growth is actually slowing from the 2.5 percent pace registered during the third quarter, something clearly at odds with the Fed's implied forecast.

After all, the fuel that supports demand comes from the job market, where worker pay is the major determinant of purchasing power.

No doubt, the October headline reading on employment is disappointing, providing another reason for stock prices to swoon early Friday morning, reinforcing the confusion coming from Europe. But a closer looks uncovers the promising signs that we believe outweigh the negatives. First off, history is being rewritten almost in real time - and painting a brighter image with each revised stroke. Specifically, the last two jobs report have come with upward revisions to previous months, a sign that initial estimates are understating the improvement in labor conditions. Remember the hoopla surrounding the August report, which revealed no increase in jobs during the month? That was the spark igniting renewed fears of a double-dip recession. Well, the following month's jobs report erased that zero, as the revised figures showed that August actually did see some net new jobs to the tune of 57 thousand - not much, but better than nothing. But the historical record looks even better in this month's report, which now puts the August gain in nonfarm payrolls at 104 thousand.

Likewise, the Labor Department green shades put a happier face on the September jobs number as well. Instead of the original estimate of a 108 thousand increase, revised figures in the October report now put the increase in nonfarm payrolls at 158 thousand during that month. In other words, the level of employment at the end of September is actually 102 thousand higher than originally thought, thanks to the cumulative additions to August and September. What is the significance of the adjustment? Two important observations come to mind. First, when the labor market is improving, upward adjustments to previous estimates are quite common, just as downward revisions are common when the job market is weakening. Hence, the revisions support the notion that a steadily improving labor market is underway. Second, the disappointing 80 thousand increase reported for October looks less unsatisfactory in light of the upward revisions. What's more, there is every reason to believe that the initial estimate for October will also be revised higher in the next employment report.

One reason for this prospect - aside from the "trend being a friend" factor - is the wide discrepancy between the 80 thousand increase derived from a survey of businesses and the 277 thousand gain shown in the Labor Department's companion survey of households. The latter, which is derived from a smaller sample than the more popular establishment survey, asks people in households whether or not they are employed. If the number is much larger than in the establishment survey, it could be that an increase in the self-employed or in small businesses is not being picked up in the survey of businesses. Over short periods, the two surveys can produce markedly different results, but they tend to converge within a six-month time frame. During the past three months, the discrepancy has been startling, with the household survey showing a monthly gain of 335 thousand compared to 122 thousand among private-sector companies. The household estimate is usually not revised, so the prospective convergence favors either an upward revision in the reported establishment figures or a stronger gain in nonfarm payrolls in coming months.

To be sure, even the outsized increase in jobs reported in the household survey barely made a dent in the unemployment rate, which slipped to 9.0 percent from 9.1 percent in September. That's because the labor force has been increasing at virtually the same pace as household employment, with both rising by about 1 million over the past three months. But that's the strongest three-month increase in the labor force since late 2006 and may indicate that improving job prospects are encouraging workers who dropped out of the labor force to resume their job search. Hence, the stubbornly high unemployment rate could well mask some underlying strength in employment conditions. With the labor force participation rate down to 64.2 percent from a 66.3 percent average over the past twenty years, the potential expansion in the supply of workers could well match the increase in job openings for some time to come, highlighting how difficult it will be to bring the unemployment rate down to normal levels.

The bottom line is that the job market continues to make progress, although at a far-too-slow pace to satisfy the army of unemployed workers or policy makers. Hopefully, the pace will pick up in coming months. One encouraging sign: the long-term unemployed are starting to find some relief. The number of workers out of a job for six months or longer plunged by 366 thousand last month, the largest one-month drop since the recession ended, and the median duration of unemployment fell to 20.8 from 22.2 weeks in September. Make no mistake, the plight of the jobless remains excruciatingly severe; but any relief is highly welcomed, particularly if more is on the way.

JPT110411-1804

J.P. Turner Named “2011 Best Places to Work in Georgia” by Georgia Trend Magazine

2011-11-02T14:28:00.000-04:00

Independent brokerage and investment banking firm J.P. Turner was nominated by home office employees and selected by Georgia Trend Magazine as one of the best places to work in Georgia for the second year in a row.

J.P. Turner & Company, LLC was named “2011 Best Places to Work in Georgia” by Georgia Trend Magazine for the second year in a row. For the past six years, Georgia Trend has conducted an online survey to identify the best places in the state to work. Companies are nominated by their employees and magazine staff comb through thousands of nominations to identify the 15 best companies in the state.

Founded in 1997 by Tim McAfee and Bill Mello, J.P. Turner is an independent brokerage and investment banking firm headquartered in Atlanta. The firm now boasts some 200 independent offices across the country and continues to grow. J.P. Turner remains privately owned with McAfee and Mello still significantly involved in the day-to-day operations.

“Tim and Bill set the standard for how we in the home office treat each other and our reps,” said Dean Vernoia, chief operating officer. “They are generous, loyal, open to new ideas, and emphasize customer service. Those are just a few examples of why the firm continues to grow despite the economic challenges of the past two years.”

Named for their two youngest sons, J.P. Turner is a family-oriented business that provides employees with a healthy work-life balance. “I don’t have to choose between having a great career and being a good mom,” said Orlette Elias, operations specialist. “I can have both.”

Read the article>>

Weekly Economic Commentary: Week of October 31

2011-10-31T08:46:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF OCTOBER 31, 2011

So, once again we have to ask: is the economy's glass half empty or half full? A month or so ago, the vast majority of economists would have said it was half empty at best, and draining quickly at worst. Recall that in mid-summer, a perfect storm of events was buffeting the economy. After stumbling through the first half of the year growing at less than a 1 percent pace, the nation's growth engine seemed to grind to a halt. Initial estimates showed that the economy generated no net new jobs in August, consumers zipped up their wallets and purses, confidence reached a low ebb and the stock market swooned, diving by more than 20 percent from its early July peak. Double-dip recession fears ran high, and the Federal Reserve was scrambling to find new ways to resuscitate activity.

Importantly, the economy's struggles were not due entirely to organic forces. Yes, the Great Recession left a legacy of headwinds that normal cyclical forces could not easily overcome. The housing market remained flat on its back and households, having absorbed a confidence-shattering loss of wealth due to the collapse in home values and stock prices, retained a mountain of debt that restrained spending. But progress towards repairing balance sheets through debt reductions was gradually taking place, and the housing market appears to have hit bottom - neither contributing to growth nor detracting from it. While these organic headwinds kept the economy's growth engine in low gear, it was a sequence of external shocks that threatened to bring the recovery to a premature end. The sequence has been well documented, beginning with an oil-price surge early in the year followed by the disruptions caused by the Japanese earthquake, a rolling European debt crisis and finally ending with the distressing debt-ceiling debacle and downgrade of U.S. government debt in August.

With the economy barely in positive growth territory, the half-empty crowd had good reason to believe the onslaught of external shocks was the last straw that would tip the nation into a double-dip recession. But that perception, so strong a month ago, has gradually lost adherents in the face of a string of positive economic news in recent weeks. The biggest upside surprise was the September employment report, which was not only stronger than expected but showed upward revisions for the two previous months. Likewise, fears consumers were going into hibernation were put to rest with a solid retail sales report for September that far exceeded expectations. To cap things off, the stock market received a breath of fresh energy, staging a remarkable rally in October. The S&P 500 index climbed 17 percent from its October 3 low through this Friday and is now in positive territory for the year.

To be sure, the steady flow of upbeat economic reports underpinned the market's newfound euphoria. But the rally enjoyed a double-dose of optimism this week, reflecting another batch of positive economic reports and the defusing - at least temporarily - of the European debt crisis. On the economic front, Thursday's release of the GDP figures for the third quarter delivered a major blow to the double-dip recession scenario. According to the government's advance estimate (which will be revised twice over the next two months) the economy expanded by a 2.5 percent annual rate during the July- September period. Historically that's hardly a barn-burning growth rate, falling well below the 3.2 percent long-term average for expansion quarters. But in the context of recent expectations and the economy's first-half performance, it is probably as good as it gets.

For one, the 2.5 percent increase was the strongest since the third quarter of last year, following increases of 1.3 percent and 0.4 percent in the second and first quarters, respectively. For another, the third-quarter climb finally lifted the level of real GDP to a new peak, surpassing the precession high reached in 2007. Technically, therefore, the economy has moved out of the recovery stage (since it recovered all of the output lost during the recession) into the expansion phase of the economic cycle. Hence, we can remove "double-dip" from the lexicon of possible recession scenarios; should the economy enter a downturn any time soon, it will be classified as a brand new and separate recession from the one that ended eight quarters ago. To be sure, the next two revisions could well dilute the gains reported by the government's initial estimate and put the level of activity back below the pre-recession peak. But that's a story for another day and should not detract from an otherwise upbeat reading that helped buoy investor confidence this week.

Indeed, the details of the report are even more promising than the headline number. The biggest contribution to the third-quarter's growth rate came from consumers, as real personal consumption increased by a solid 2.4 percent rate. That's the strongest gain of the year and accounted for 1.72 percentage points of the 2.5 percent GDP increase. Nor was the consumption gain distorted by a spike in one or two categories, such as volatile auto sales. While the latter did increase as expected, the major increases came from the much-larger service sector, where a broadly distributed 3 percent gain was the strongest in more than four years. What's more, the third-quarter increase was heavily back-loaded. According to a follow-up government report on personal income and spending released on Friday, real consumption increased by 0.5 percent in September, matching the largest monthly gain since August 2009, the first month of the recovery.

With consumer spending accounting for 70 percent of GDP, the September reading indicates that the economy has some forward momentum heading into the fourth quarter. If consumption holds on to its September gain or, more likely, posts modest additional increases in November and December, another driver of growth will kick in, namely inventory restocking. As we noted in last week's commentary, businesses responded quickly to the first-half slowdown in growth, paring inventories and curbing new orders for goods to stockpile. That behavior is documented in the GDP report, as the slowdown in inventory accumulations subtracted a sizeable 1.1 percent from the third quarter's growth rate. In other words, real final demand, after adjusting for inventory changes, increased by 3.6 percent, far stronger than the headline 2.5 percent GDP increase. Simply put, businesses have some catching up to do if final demand holds up, and the potential impetus from inventory rebuilding could give the fourth quarter's growth rate a solid lift as well.

Meanwhile, businesses continue to invest heavily in new equipment and software. Capital spending increased by a hefty 17.4 percent annual rate in the third quarter, contributing an outsized 1.2 percentage points to the overall growth rate. Thanks to robust profits and ample cash on hand, companies have the financial resources to underwrite spending gains and are likely to continue making up for the plunge in capital outlays that occurred during the recession. New orders for nondefense capital goods less aircraft, a reliable measure of capital spending prospects, have increased steadily over the past five months, with September's 2.4 percent jump the largest of the period. Significantly, the long drought in commercial construction appears to be coming to an end, as companies are increasing investment spending on factories, shopping malls and office buildings. In the third quarter, outlays on structures increased by 13.3 percent, following an even larger 22.6 percent gain in the second quarter.

Hence, instead of staring at a double-dip recession, the economy has taken a big step back from the precipice. Given the momentum that appeared to be building in September, it would take a major shock to prevent another positive growth rate from taking place in the fourth quarter. But before uncorking the champagne, there are several caveats that take some of the joy out of the celebration. For one, no matter how it's sliced and diced, the recipe for a self-sustaining robust expansion is missing some key ingredients. The most obvious of course, is that a 2.5 - 3 percent growth rate that seems to be on track for the second half of the year is not sufficient to make a meaningful dent in unemployment. Recall that the last time the unemployment rate crossed below the 9 percent threshold, falling from 9.2 percent to 7.2 percent in less than a year following the 1981-82 recession, the economy had posted four consecutive quarterly growth rates surpassing 8 percent in 1983. The odds of that happening in the foreseeable future are slim to none.

Indeed, there are compelling reasons to believe that the pick-up to even the modest growth rate in the second half of the year largely reflects the unwinding of transitory shocks. But the positive momentum stemming from the restoration of auto production after the Japanese earthquake, the easing of gasoline prices over the summer and the temporary resolution cobbled together by the EU to tone down the European debt crisis will not have legs unless firmer underpinnings are put in place. First and foremost, of course, is the imperative of a stronger job market, which is a precondition to sustain demand beyond the next several months. In fact, the solid rebound in real consumption during the third quarter is coming under scrutiny from skeptics who are convinced that the gain will soon peter out.

One reason, aside from concerns about the strength of the job market, is that households may be running out of firepower. While the 2.4 percent gain in expenditures during the period exceeded expectations, it also exceeded the growth in incomes. Disposable incomes increased by a puny 0.6 percent in the third quarter, which means that households had to save less to accommodate the increase in purchases. In point of fact, the personal savings rate slid to 3.6 percent in September, the lowest it has been since December 2007. Whether the willingness of households to dip into savings is a sign of confidence in the future or a defensive reaction to diminished purchasing power remains to be seen. But the plunge in the Conference Board's measure of consumer confidence to the lowest level since the depths of the recession in 2009 is not a particularly encouraging omen.

Our sense is that the economic glass is half full rather than half empty but we expect it to fill up at a painfully slow pace. Households still have a ways to go before they feel comfortable with their financial health, much less job and income prospects. With savings down and debt burdens still high, they are unlikely to spend at a much more vigorous pace in coming quarters. But the job market should strengthen somewhat, which will provide some support for consumption and keep the economy on a positive growth track. Perhaps the biggest caveat looming ahead is fiscal policy. If Washington cannot agree on a deficit reduction plan and inexplicably lets the temporary payroll tax and other stopgap measures aimed at stimulating growth expire at the end of the year, all bets are off. Ordinarily we would assume that rational minds will prevail, but with a presidential election year coming up and the deep partisan divide in Congress favoring gridlock, nothing should be taken for granted.

JPT102811-1746

Weekly Economic Commentary: Week of October 24

2011-10-24T09:19:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF OCTOBER 24, 2011

To say the U.S. economy is out of the woods would be a huge leap of faith, as well as an exaggerated interpretation of recent promising events. Yes, the nation appears to have dodged an immediate recession threat. By all accounts, the economy not only continued to grow in the third quarter, it expanded at a markedly faster pace than in the first half of the year. The preliminary estimate of GDP for the period will be released next week, and we will delve more deeply into the data then. Odds are, the fourth quarter will see positive growth as well, as many of the forces boosting activity in the July - September period should remain in place.

But the second-half improvement owes much of its vigor to the unwinding of temporary shocks that curtailed activity over the first half of the year. The earthquake and tsunami in Japan shut down the flow of parts to the auto industry during the spring, slashing motor vehicle production and sales for several months. By the summer, however, Japanese production had been brought back online, enabling the auto industry to restore full production schedules. Hence, following a 15.7 percent drop in the second quarter, production of motor vehicle and parts snapped back by 21.3 percent in the third quarter, giving the manufacturing sector a sizeable boost. Industrial production overall posted an annual rate of gain of 5.1 percent in the third quarter, following a tepid 0.4 percent increase in the April-June period.

The momentum from a rebounding auto sector will fade in coming months, but further production gains are likely. One reason: companies have been extremely cautious about holding inventories in the face of political uncertainties, weak job growth and expectations of sluggish consumer demand. Imports of consumer goods have slowed, manifested by low shipping volumes reported at key loading points, which is usually a barometer of how U.S. purchasing managers view upcoming holiday sales. But consumers have been surprisingly resilient in recent months, as evidenced by the stronger-than-expected retail sales for September as well as the upward revisions to July and August, leaving merchants vulnerable to inventory shortages - and lost sales - during the holiday season. In August, the ratio of inventory to sales among retailers stood at a lean 1.34 compared to 1.39 a year ago. Simply put, the need to rebuild inventories could well boost production of consumer goods. Sharp inventory swings are a time-honored cyclical force that has historically given recoveries a temporary burst of momentum.

Then there is the unwinding of the gasoline price shock that sapped household purchasing power during the first half of the year and crimped spending. The climb reflected in large part the Libyan uprising as well as strong global demand, particularly from rapidly-growing developing countries that fueled speculation of oil shortages. But prices at the pump have retreated by about 50 cents a gallon from the peak reached in early May, as abrupt growth slowdowns in the developed world spread to China, India, Latin America and other emerging market nations. What's more, fears of a supply cutback from Libya receded as the rebels moved closer to victory; with Gadhafi's death on Thursday and the soon-to-be emergence of a new government, oil supplies should get a lift from increased Libyan output.

But it's questionable if the unwinding of these temporary shocks will provide enough momentum to carry the economy beyond the next few months. Consumers have dipped into their savings to finance purchases, as the personal savings rate slid from 5.30 percent in June to 4.5 percent in August. This is not a sustainable trend as households still have a ways to go before their balance sheets are restored to health. While the total debt to income ratio has fallen to 119.5 in the second quarter from a peak of 135.5 in 2007, it remains a whopping fifty percent above the 81.7 average over the 1980-2000 period, just prior to the debt-fueled spending binge that ultimately came to a crushing end.

Much of the excessive borrowing during the period was validated by rising home prices, which provided households with the collateral and equity to draw on. The sad reality is that home values, like that of most assets, can decline as well as appreciate, whereas debt obligations remain on the ledger. Hence, not only do debt burdens account for a substantially larger fraction of incomes than is historically the case, they also would take a bigger bite out of assets if households had to liquidate them to satisfy debtors. In the second quarter, total debt accounted for 19.2 percent of total assets. While that's down three percentage points from the nearby peak in 2009, it remains well above the 14.3 percent average share from 1980 through 2000, just before the housing boom got underway. What's more, the lion's share of the debt liquidations in recent years has been a product of foreclosures, distressed home sales and bank write-offs of soured consumer loans. While that makes balance sheets of households seem better statistically, it also reduces credit scores, making it more difficult for them to obtain loans in the future.

Under these circumstances, the use of savings to finance purchases does not put households further on the road to financial health. We suspect that consumers will turn more frugal on that score, and continue with the deleveraging process that has been underway for the past three years. Perhaps the first hint of that came in August, when consumer credit, excluding mortgages, plunged by $9.5 billion, the first cutback in eleven months and the largest monthly reduction since February 2010. Does that mean the retail sales bounce in September was a fluke, portending a retrenchment in spending during the final quarter of the year? Not necessarily. Keep in mind that debt levels do not draw a complete picture of the capacity of households to service their obligations. With interest rates driven down to rock-bottom levels by the Federal Reserve alongside modest income gains, the fraction of household budgets devoted to monthly debt repayments has declined much more steeply than has debt levels.

Indeed, debt repayments accounted for only 11.1 percent of disposable incomes in the second quarter, the lowest in fifteen years and well below the 13.85 percent peak seen in 2007. The second-quarter reading is actually below the 11.5 percent 1980 - 2000 average, so by this measure at least, households appear to be in decent financial shape. But looks are deceiving, as the biggest contributor to the decline in the debt repayment ratio can be found in the numerator - debt principal, which reflects the aforementioned foreclosures and write-offs, and interest rates. It is the denominator, i.e., the income side of the financial equation that needs improvement if households are to grow out of their debt obligations. Sadly, progress on that front has been slow in coming.

Not only have income gains been handcuffed by the weak job market, worker pay has been eroded by inflation. In September, real average weekly earnings of all nonfarm workers stood at $349.42 compared to $350.14 in August 2009, the first month of the recovery. Worse, the slide has gotten steeper this year, with real earnings falling by 2 percent over the past twelve months. The good news is that the drag on purchasing power from higher prices is set to recede. For the most part, the acceleration in inflation this year has been a product of sharply rising oil and other commodity prices. In September the consumer price index increased 0.3 percent, lifting the twelve-month inflation rate to 3.9 percent, the steepest in nearly three years. The so-called core CPI, which excludes volatile food and energy prices, also matched a near three-year high, posting the same 2 percent 12-month increase as in August. But the core trend reflects the lagged effects from rising oil and commodity prices that pushed up the headline CPI earlier in the year -- and those effects are now easing. In September, the core CPI rose by only 0.1 percent, the slimmest gain in six months.

Not only are energy prices well off their peak, but other prices that boosted the headline CPI earlier this year are also retreating. Motor vehicle prices fell in September after surging by 1.1 percent in May and 0.6 percent in June. The earlier increases reflected a shortage of auto inventories due to the aforementioned Japanese disaster that also crimped production. That shortage drove consumer to used vehicles, causing big price increases there as well. With auto production now in full swing and dealer lots displaying more vehicles for sale, prices are predictably coming down. Likewise, the housing meltdown has produced a major shift away from home buying to renting. The surge in demand for apartments overwhelmed supply, creating a shortage in rental units that drove up rental costs.

That too is unwinding, as the rent increases encouraged builders to step up construction of new multifamily properties. In September, multifamily housing starts soared by 51.3 percent to 233 thousand units, the highest since a similar number in October 2008. Permits for multifamily construction remained elevated in September, although down from their recent peak, indicating that this trend will remain in place for a while. As these starts reach completion, the supply of rental units will balloon accordingly, putting more downward pressures on rents that will filter through to a lower inflation rate. Simply put, the squeeze on worker pay from higher prices should ease in coming months, boosting the purchasing power of households even as wages and salaries are constrained by the sluggish pace of job growth.

We suspect that there is enough firepower from the unwinding of transitory shocks to give the economy a decent lift over the final quarter of the year. Particularly encouraging is that the fading of these transitory forces is being reinforced by signs of an improving job market. One such sign was the stronger-than-expected increase in nonfarm payrolls reported for September; the fall in first-term claims for jobless benefits this month suggests that October could also surprise on the upside. But before uncorking the champagne, there is still a wall of worry to climb that could well stifle growth before it gains momentum. The still unresolved European debt crisis continues to be a potential source of financial turbulence that could undercut confidence and growth. Uncertainty over fiscal policy remains another threat. There is a great deal of pessimism that Congress will not come up with a workable long-term deficit-reduction plan and that the president's jobs bill will get hijacked by partisan politics, allowing the temporary payroll tax cuts to expire at the end of the year. If that pessimism is validated, it will take more than the unwinding of transitory shocks to keep the recovery alive.

JPT102111-1693

Weekly Economic Commentary: Week of October 17

2011-10-17T08:28:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF OCTOBER 17, 2011

Thanks to a string of better than expected data in recent weeks - punctuated by last Friday's relatively upbeat jobs report for September - the economy appears to have backed off the recession ledge, at least for now. Indeed, our misty eyes even observed some forecasters lifting their near-term growth outlook, a welcome sight following the reams of downgrades that have taken place in recent months. The latter includes that of the Federal Reserve chairman, who noted the "recovery was close to faltering" in congressional testimony just two weeks ago. Mr. Bernanke was particularly concerned about the potential fallout from the long-simmering European debt crisis, but he also noted that the recovery has generated a much weaker pace of job creation, consumer spending and business investment than expected for reasons that aren't entirely clear.

And that's the problem: there are so many diffuse forces holding back the recovery that it is impossible to identify - and hence zero in on - any single perpetrator. It goes without saying that once you identify the source of the problem, finding a solution is much easier. Take the lackluster labor market, which has recovered only 2.1 million of the 8.75 million jobs lost during the Great Recession. Are companies holding back on hiring because of weak demand prospects or fears surrounding the global financial turmoil? Or is a divisive political climate disrupting longer-term planning decisions because of uncertainty regarding regulations, taxes, health care costs or broader fiscal policy actions? As we have frequently noted in the past, uncertainty is the enemy of growth, and the current environment has more than enough imponderables to keep decision makers in a defensive mindset.

Given the diverse nature of the problem, even the great minds of the time understandably disagree over what appropriate actions should be taken to jump-start the economy. Many mainstream economists fervently believe in the Keynesian approach, advocating more government stimulus to fill the gap left by weak private spending. Conservatives take the opposite view. They believe that past deficit spending and its legacy of huge government debt is what got us into this mess in the first place, and more of the same will simply aggravate the problem. Similar pros and cons are evolving around monetary policy, with some advocating more aggressive action by the Fed and others less. Perhaps the best that can be hoped for is that policy makers at least avoid making the wrong decisions, which would simply make a bad situation worse. If that condition is met, the economy's fate could well be determined by father time, wherein market forces will either blossom into a stronger, healthier recovery or be crushed by the weight of multiple drags and external shocks that eventually bring on another recession.

Our sense, in line with many economists, is that the economy will muddle through in coming months and quarters, neither fading away nor picking up significant momentum. The history of past financial crises and housing busts is that recoveries take longer to gain traction and are considerably weaker in its earlier stages than is the case following plain vanilla recessions. This upturn is unfolding very much according to that script, although the hole dug by the Great Recession is much deeper than most past crises and the uphill climb is therefore much harder to navigate. Nonetheless, the climb is continuing and there are more reasons to believe it will ultimately morph into a full-fledged expansion than fade away. That prospect may not be on the near-term horizon, but the threat of an imminent downturn, which was clearly prevalent over the summer months, has receded.

One reason is that the economy appears to have survived the biggest body blows delivered by the debt-ceiling debacle, the ongoing European debt crisis, supply disruptions caused by the natural disaster in Japan and the surge in oil and food prices over the first half of the year. Those confidence-shattering shocks were no doubt largely responsible for knocking a few percentage points off of the economy's growth rate, which slipped below 1 percent during the January-June period. However, a more promising chapter is being written as the autumn gets under way. As noted, the job market is perking up a bit, with the September gain in payrolls reported last Friday considerably stronger than expected. The July and August figures were also revised sharply higher, generating more income and purchasing power to support consumer spending, the bedrock of any recovery.

That support was further documented this week with the release of the retail sales data for September. Sales for the month rose a sturdy 1.1 percent from August, a much stronger increase than the 0.8 percent or so expected by the consensus of economists. And, as was the case with the jobs figures, retail sales for July and August were also revised higher. With consumer spending accounting for about 70 percent of GDP, the stronger readings over the past three months spurred the upward revisions to the growth forecasts by a number of economists. It now looks like the third quarter will register a growth rate above 2 percent, with some putting it over 2.5 percent, which would be a solid acceleration from the 1.3 percent posted in the second quarter and the measly 0.3 percent in the January-March period. There are still holes to fill, as

September data for inventories, production and consumer spending on services are still missing. But there is little reason to expect a major setback in those indicators, and production could actually get a nice lift from the rebound in auto output.

Indeed, autos accounted for a big chunk of the retail sales gain last month, rising by a robust 3.6 percent and contributing nearly half of the overall increase. The strength in auto sales is not surprising, given that the industry had already reported a sizeable increase in unit car sales during the month. But the auto boost, while welcomed, should not obscure the other positive aspects of the report. For one, the overall increase of 1.1 percent was the strongest since February, just before gasoline prices took off and sapped household purchasing power, not to mention confidence. For another, sales outside of the volatile auto and price-driven gasoline sectors also registered solid gains, spread across a broad range of products. That group, representing 71 percent of total retail sales, rose by 0.5 percent in September for the second consecutive month, marking the strongest back-to-back increases since February/March.

Perhaps the most encouraging aspect of household behavior last month was that consumers stepped up spending at food services and drinking places. This category is frequently viewed as a good proxy of discretionary spending trends and, by extension, a measure of consumer confidence. In September, these establishments enjoyed a solid 1.2 percent increase in revenues, only the third monthly gain of more than 1 percent in three years. Sales at food service and drinking establishments stood at $4.16 billion during the month, 6.9 percent higher than the corresponding year-earlier month. That's the strongest year-over-year increase since July 2007, months before the Great Recession began.

To be sure, the September spike could well turn out to be an outlier rather than a reflection of improving fundamentals or consumer optimism. But it is probably no coincidence that it comes on the heels of declining gasoline prices in recent months. Since reaching a peak of $4.02 a gallon in early May, retail prices at the pump have slid to an average of $3.67 in September. The slide continued into this month, with average nationwide prices falling to $3.48/gallon in the week of October 10. Since the consumption of gasoline is relatively inelastic, the lowered cost of filling up the tank puts extra cash in the pockets of households that is more likely to be spent on discretionary goods. Alternatively, lower gas prices may give consumers an extra incentive to drive to an eating establishment.

While the September retail sales report, like the jobs report, is encouraging, it would be a mistake to believe that consumers are off to the races, ready to propel the recovery into a significantly higher gear. As we noted earlier, the most likely scenario we see unfolding is one that avoids a recession but still faces powerful growth-retarding headwinds. A growth rate of 2 - 2.5 percent over the second half of the year would be a significant improvement over the economy's first-half performance, but not yet strong enough to put the recovery on a solid footing. At best, it would generate about 125-150 thousand jobs a month, which is only a tad more than the increase in the working age population. Hence, the unemployment rate is not poised to come down drastically any time soon.

What's more, if the labor force participation rate starts to rise from its extremely low level - which improving job prospects are likely to bring about - the jobless rate could well edge higher over the course of the year. Indeed, many economists expect the rate to climb back towards 10 percent from the current 9.1 percent for precisely that reason. That would be an unfortunate side effect of an improving economy, one that the Obama administration would have a hard time putting a positive spin on leading up to the election. Still, if the pace of job creation also shows tangible improvement, a convincing case for this dichotomy could be made. Of course, the president would have to counter an equally compelling negative spin that would undoubtedly be presented by the Republicans. Just how the public balances out the arguments remains to be seen, but the stage is being set for another political battle that will disseminate a lot of misinformation and create more uncertainty, which can only be detrimental to growth prospects.

While 2012 is shaping up to be a year dominated by highly divisive political dialogue, the more immediate threat is the rhetoric that will no doubt grab headlines in the weeks leading up to the November 23 deadline for the Super Committee charged with coming up with at least $1 trillion in budget cuts. Recall that the agonizing debt-ceiling debate had a major impact on consumer confidence as well as the financial markets over the summer, which probably took a big toll on spending and hiring. The odds for a more peaceful resolution of the looming budget debate are pretty low, in our view. Whether that will make companies more reluctant to hire workers remains to be seen, but it is a wild card in the near-term outlook that makes us less optimistic about the economy's prospects than would otherwise be the case.

JPT101411-1628

Weekly Economic Commentary: Week of October 10

2011-10-10T09:03:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates

WEEK OF OCTOBER 10, 2011

We love happy endings and remain hopeful that the tale of this trouble-plagued recovery will end up like one of those old Doris Day-Rock Hudson movies. The more we watch the unfolding scenario, however, the more it looks like the Rocky Horror Picture Show. From our lens, the foreign cinema is producing the most blood-curdling films. The American version, while not entirely upbeat, is becoming more bearable to watch, at least for now. But there are interconnected strands that influence both filmmakers and it's unclear if we will be viewing a happy or sad ending when all is said and done.

Clearly, foreign producers are taking the dismal science to its most literal extreme, as it is hard to find anything to like about the evolving drama overseas. Greece continues to be the main protagonist, missing its budget targets and moving ever closer to defaulting on its outstanding debt. European leaders remain divided over how to deal with the problem, although most seem to acknowledge the gravity of the situation. As they dither and vacillate, the European economy has ground to a standstill, reflecting the bite from fiscal austerity throughout the region, sinking confidence and mounting pressure on major banks that underpins a looming credit squeeze. With ominous signals flashing ever more brightly, euro-zone officials are stepping up the timetable to create a safety net around the troubled banking system, beefing up an array of bailout funds and forcing banks to accumulate more capital to withstand major write-offs that are sure to come.

Whether the European officials start to move fast enough to get ahead of the curve remains to be seen. Until now they seem to have been one step behind, responding to each incremental crisis with new proposals. Despite the numerous missteps that characterized the U.S. response to the 2008 financial crisis, the one unassailable fact is that the policy makers were willing to take bold and risky measures to safeguard the financial system. Some proved to be disastrous and were dismantled in short order, but the willingness to throw the proverbial kitchen sink at the evolving crisis is arguably the reason why the crisis did not morph into an outright catastrophe, which many feared was inevitable. To be sure, that massive rescue mission has left a bitter legacy of winners and losers, with many perceiving the winners residing on Wall Street and the losers on Main Street. That perception continues to resonate throughout the nation, highlighted by the current protesters filling the streets of lower Manhattan and sprouting up in a handful of other states.

As noted earlier, however, there are common strands connecting the woes in Europe with the U.S. and the evolving crisis overseas could yet spill over to our domestic shores. Clearly, U.S. banks are not immune from a potential sovereign debt default as they are linked in many ways to the fortunes of European banks. Still, American banks took much bigger strides towards rebuilding capital following the 2008 financial crisis than did their foreign brethren; hence, they are in much better shape to weather the gathering storms. Unlike in Europe, it is not a wobbly financial system that is undermining the economic recovery. Instead, the U.S. is grappling with a crisis in confidence, a weak labor market, moribund housing activity and divisive politics that is reinforcing the confidence erosion underscoring a lackluster pace of spending and hiring. The financial crisis overseas is, unfortunately, imposing another layer of uncertainty over households and businesses, which is no doubt contributing to the economy's underperformance.

Against this backdrop, it is not surprising that fears of a double-dip recession have filled the air during the better part of the summer. After growing at a tepid annual rate of less than 1 percent during the first half of the year, the economy showed no signs of gaining traction over the summer. Indeed, the job-creating engine downshifted abruptly from April through August, with the preliminary figures showing zero growth in August. Clearly, it would not take much to tip the economy over the precipice into another downturn, and the debt crisis in Europe seemed to be a potent candidate to do the job. None other than Fed chief Ben Bernanke opined this week that the U.S. recovery was faltering in part due to the uncertainty generated by European financial crisis. President Obama echoed that theme this week in pushing for his $447 billion jobs bill, which he deems vital to get the economy back on track (not to mention his reelection prospects).

Needless to say, the financial markets approached the release of this Friday's monthly jobs report with much trepidation. Another dismal reading, similar to August's report that revealed no increase at all during month, would certainly have caused the double-dip alarm bells to ring even more vehemently. Fortunately, the news was not as bad as feared. Indeed, by most measures the jobs report turned out to better than expected, providing a sigh of relief to nervous investors. At the end of the day, neither the pessimists nor the optimists could claim victory, but even the doomsayers would admit that the report could have been considerably worse.

First let's delve into the positive elements of the report. The economy did generate jobs in September, as nonfarm companies added a net 103 thousand workers to payrolls during the month. That was considerably more than the 50-75 thousand expected by Wall Street. Even more encouraging, the results for the previous two months were revised sharply higher. August can no longer be called a jobless month, at least until the final revisions are in. The latest revision, however, added 57 thousand workers to payrolls during the month, which paints a much healthier labor market picture than one that has zero growth on the canvass. What's more, job creation in July turned out to be stronger as well, as the revised figures show an increase of 127 thousand nonfarm payrolls compared to an original estimate of an 85 thousand gain. All told, the government added 99 thousand jobs to the previously released data for July and August, buttressing the stronger than expected 103 thousand increase in September.

What else? Well the gains in September were fairly widespread, with only the manufacturing sector showing a significant loss among private companies. The diffusion index, which tracks the percentage of private industries that are expanding payrolls, stood at 55.4 percent, indicating that the majority are adding workers. Among the biggest gainers, the Business and Professional Services grouping added a sturdy 48 thousand workers, much stronger than the 26 thousand average over the previous three months. Within that sector, temporary help agencies provided 19 thousand workers, following a sizeable 20 thousand increase in August. This is good news because companies tend to hire part time or temporary workers as a prelude to expanding permanent staff, which requires higher fixed costs, and serves as a sort of leading indicator of future hiring trends. Even the beleaguered construction trades got positive news, as a surprising 26 thousand hard hats were hired in September, the most in seven months. It's unclear, however, is this spike reflected primarily rebuilding efforts from Hurricane Irene, or a stabilizing trend in the construction industry.

Existing workers also saw their paychecks fatten, as average hourly earnings increased by 0.2 percent in September. That completely offset a 0.2 percent drop in August, and brings the 12-month increase to 1.9 percent. While the monthly increase is not large, it accompanied an increase in the average workweek, which suggests that personal incomes enjoyed a solid boost from wages and salaries during the month. Nothing contributes more to spending power than labor income, and the fatter paychecks last month goes a long way towards explaining the resilient shopping behavior of consumers reported by chain stores in recent weeks.

This is another example of watching what consumers do rather than what the say they feel, as their spending habits belie the dour mood manifested in recent consumer confidence surveys.

But it would be foolhardy to heap copious amounts of praise on the September jobs report. Yes, it was clearly better than expected and depicted an economy that continues to grow. What's more, the 103 thousand net gain in nonfarm payrolls was dragged down by the persistent decline in government payrolls, which fell by another 34 thousand in September. Hence, private employment actually rose by a more impressive 137 workers. But that gain was inflated by the return of 45 thousand striking Verizon workers, who were not counted as employed in August. Netting out the Verizon effect, the combined increase for August and September sums up to 179 thousand, or about 90 thousand a month. Not only is that considerably less than the 166 average monthly gain posted from January through July, it is not enough to keep up with population growth.

Accordingly, the unemployment rate stayed at its elevated 9.1 percent level reached in August. This metric, of course, is derived from a separate survey of households that produces much more volatile results than the establishment survey, which is derived from a larger canvass of business establishments. Over time, however, they paint a fairly consistent picture of labor market trends. Like the establishment survey, the household figures present a mixed reading. The positive news is that a whopping 398 thousand households who said they searched for a job in September found one - the largest increase in 17 months. The reason that didn't lower the unemployment rate was because an even larger number, 423 thousand, of workers either entered or reentered the labor force. But even that has a positive aspect, as a rise in the labor force participation rate suggest that workers who had stopped looking for a job are feeling more optimistic about finding one and, hence, are resuming their search.

Sadly, however, an outsize fraction of those labor force entrants are only finding part-time jobs. The number of people working part-time for economic reasons - meaning they could not find full-time positions - surged by 444 thousand during the month to 9.27 million, the highest in a year. These folks, along with discouraged workers, are included in a broader U-6 measure compiled by the Labor Department to gauge the extent of underemployment in the labor force. Here the news is unambiguously negative. In September, the U-6 rate rose to 16.5 percent from 16.2 percent in August and a recent low of 15.7 percent in March. Simply put, the September jobs report could have been much worse, but that's a far cry from saying it was good. The best that could be said is that all of the shocks that buffeted the economy in August and September, including the debt-ceiling debacle, stock market turmoil, the European debt crisis, the ratings downgrade of Treasury securities and the plunge in household as well as business confidence, did not spur companies into contracting payrolls. While that may provide a sense of relief to policy makers, it certainly is not the happy tale that marks the end of a Doris Day-Rock Hudson movie. Clearly, the script for this story is still being written, with unwanted help from European contributors.

JPT100711-1569

J.P. Turner Named Top 10 Atlanta Brokerage Firm

2011-10-05T16:11:00.000-04:00

The Atlanta Business Chronicle has again named J.P. Turner & Company, LLC one of Atlanta’s Top 10 Brokerage Firms. The survey, which ranked firms by the number of brokers in Atlanta, was released on September 9 and positions J.P. Turner alongside industry leaders like Morgan Stanley Smith Barney, UBS Financial Services, Edward Jones and Raymond James Financial.

Founded in 1997 by Tim McAfee and Bill Mello, J.P. Turner has evolved from a traditional brokerage firm to a full service investment firm. In addition to brokerage services the firm has added an investment banking division, managed products, energy and real estate investment practice areas and offers fee-based advisory services through its affiliate company J.P. Turner & Company Capital Management, LLC. The firm has a network of some 200 independent branch offices and more than 550 representatives across the country. To learn more about J.P. Turner, visit www.jpturner.com or www.jpturnercm.com. To obtain information on becoming a J.P. Turner independent representative please visit www.joinjpturner.com.

Weekly Economic Commentary: Week of October 3

2011-10-03T08:43:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF OCTOBER 3, 2011

It may just be a case of grasping at straws, but there's a glimmer of hope that political leaders might actually take some of the steam out of the financial turbulence gripping the global markets. The German parliament, for one, give its approval on Thursday to bolter the size and flexibility of the bailout fund that is designed to prop up the weaker economies in the euro zone, most notably Greece. While many view the $600 billion fund, to which Germany is the largest contributor, as too small meet the burgeoning problems in the region; it at least douses a fuse that threatened to undo the single currency system and ignite a full-blown financial crisis. Likewise, the U.S. Congress approved another stopgap spending bill that will enable Washington to keep operating, at least for another week or so.

But it's far too premature to pop open the Champagne. At best, government officials are applying a band-aid to an open sore that will require more drastic remedies at some point. The European debt crisis is reaching a boiling point, and there is wide disagreement among experts over whether it will ultimately engulf larger nations, such as Italy and Spain, which could then threaten the solvency of major banks throughout the Continent, leading to the aforementioned financial crisis. Nor are U.S. banks immune from the contagion effect, as they are counterparties to untold trillions of dollars in derivatives linked to shaky sovereign debt. And anyone who thinks the U.S. Congress will smoothly approve a bipartisan spending bill when returning from recess after October 4, well there's a bridge for sale that's looking for gullible buyers.

Still, the patchwork of actions taken this week at least provides a temporary respite for anxious investors fearful that government officials are burying their heads in the sand. There is a sense that political leaders are realizing the gravity of the situation that confronts them, and are at least talking about the tough decisions that need to be made in coming months. Let's hope that the right ones prevail. If Europe continues on the path of imposing more austerity measures on the weaker members of the EU, the crisis would not only be prolonged, it would intensify. Instead of lowering debt burdens restrictive fiscal practices, such as massive layoffs of public workers, reducing salaries and increasing taxes, would make it even more difficult for struggling nations to grow out of their debt obligations. There are no easy alternatives, of course, as the stronger nations - particularly Germany - are not ready to provide more financial aid to Greece or to beef up the bailout fund even further. But Angela Merkel is trying her best to convey the message that a Greek default or a breakup of the single-currency union would greatly harm German banks as well as the economy. Her message is not yet widely accepted among German citizens and a fractious German legislature. But, as we said, at least the options are being spelled out more realistically, which could lead to more realistic action going forward.

Meanwhile, tensions in the global financial markets continue to build. The 3-month London-Interbank Offered Rate (LIBOR), at .37 percent this week, is at the highest point of the year. That's still well below the post-Lehman crisis of 5.7 percent reached in September 2007 when credit flows dried up because banks refused to lend to each other. Nonetheless, the ECB is working overtime to provide some struggling European banks with liquidity and is stepping up its purchases of sovereign debt to stem the rise in borrowing costs for Italy and other governments. That strategy seems to be working for now, but again a band-aid is a poor substitute for a longer-term solution. European banks need to strengthen their balance sheets with more capital before investors gain more confidence in their ability to withstand the gathering storms, including potential large write-offs of wobbly sovereign debt. This is one area of agreement among European officials, which is leading to some positive action by banks in Spain and elsewhere. On this score, American banks are in much better shape, having built up a formidable capital cushion following the 2008 financial crisis.

But while a healthier banking system is a precondition for a sustained recovery, it is not a guarantee of one. That observation is clearly evident in the U.S. where the economy continues to struggle more than two years into an upturn. Part of the problem, of course, is that credit is still not flowing as freely as it should to hard-hit sectors, such as housing and small businesses, despite stronger balance sheets of financial institutions. The housing sector is the poster child of this dysfunctional environment. Mortgage rates are at record lows, sliding to 4.01 percent this week from 4.22 percent a month ago. But mortgage lending continues to be stymied by tighter credit standards, which are shutting out all but the most creditworthy borrowers; what's more, overly conservative housing appraisals are killing deals already negotiated.

On the demand side, buyers are hardly ready to step up to the plate for a variety of reasons. Despite record-low mortgage rates that have contributed to near-record home affordability, households are having trouble qualifying for a loan, either because of low credit scores or the inability to pony up enough of a down payment. As noted above, banks have toughened lending standards in the aftermath of a housing bust that has eviscerated $6.5 trillion of home equity and sent millions of homeowners into foreclosures. For those who can qualify for a loan, many are still holding back, expecting even lower home prices down the road. Sluggish sales, in turn, create a vicious self-reinforcing cycle. Keep in mind that a sizeable portion of transactions consists of homeowners looking to trade up to a larger or, at least, different home that is more consistent with changing needs. But if they can't sell their current residence, such a trade-up sale is thwarted.

Needless to say, the new home sector is more deeply affected by these dampening factors than the existing home segment of the market. That's because resales of existing homes benefit from greater price flexibility as well as more creative loan financing arrangements. As can be seen in the chart, reproduced with updated sales figures from last week, sales of existing homes are well above the low point reached during the housing crisis, thanks in good part to deep price discounts on distressed properties that account for about one third of all transactions. Builders, on the other hand, cannot compete with the resale market on prices or offer some of the generous financing terms that a buyer in the resale market might obtain, which could include the participation of the seller. Additionally, a sizeable portion of existing home sales consists of all cash transactions by investors seeking to snap up bargains, particularly properties involved in distressed sales.

Not surprisingly, as the chart shows sales of new homes continue to languish, with the total falling by another 2.3 percent in August. At an annual rate of 295 thousand, sales in the latest month are above the all-time low of 278 thousand hit in August 2010, but the pace is still among the lowest monthly totals ever recorded for this series. There is one bright spot, however. Builders have been so cautious in response to the depressed housing market that their inventories of unsold homes have fallen to a record low of 162 thousand units. That may not be anything to cheer about in the immediate future, but such a slim overhang in the new home market suggests that even a modest demand rebound in this sector would lead to a swift response by builders. In contrast, the resale market is hardly coiled for as sharp a recovery, as it remains severely burdened by a huge overhang of unsold properties buttressed by a formidable shadow inventory of homes in the foreclosure pipeline.

To be sure, the housing market is being viewed through the lens of the current lackluster economic environment. Clearly, there is a "chicken and egg" factor at play here. History reveals that a vigorous recovery requires a vigorous snapback in housing activity following a recession. But a strong housing rebound requires more than just low mortgage rates or favorable credit conditions. It also requires growing confidence by potential homebuyers in job and income prospects as well as a conviction that the recovery has staying power. Those conditions are hardly present now. The best that could be said about recent consumer confidence measures is that they are not getting worse. Both the Conference Board and University of Michigan released their September readings this week, and both gauges edged up ever so slightly from their depressed levels hit in August. As can be seen, except for the immediate aftermath of the financial crisis in 2008, confidence is lower than the trough seen in previous recessions.

Granted, household psychology has been deeply affected by the array of external shocks in recent months, particularly the debt-ceiling debacle in late August that undercut public confidence in Congress and the administration. Historically, it takes several months before confidence recovers from external shocks, so the dismal reading in September may be more of a hangover from August than anything else. But the surveys also ask households about job prospects and buying plans and the responses to both of those questions are anything but promising. Simply put, households remain pessimistic about current and future conditions, which doesn't bode well over the near term for the housing market, much less the broader economy.

But confidence measures tend to be more of a coincident than a leading indicator. There is a time-honored observation that it is better to watch what people do rather than what they say. With regards to consumers, they actually have been behaving more positively than their mood would suggest. According to government figures released on Friday, personal expenditures increased by 0.2 percent in August. By itself, that's nothing to write home about, but it follows a robust 0.7 percent jump in July so at least households didn't zip up their purse strings following the previous month's spending spree. True, prices ate up practically all of the spending gain in August, as real consumption was flat during the month. But again, that followed a solid 0.3 percent real increase in July, leaving the average annual rate for the two months about 1.5 percent above the second quarter average. Given reasonable assumptions about the other one-third of GDP, that implies a growth rate of about 2.5 percent in the third quarter, assuming no abrupt setback in September.

A 2.5 percent growth rate still does not measure up to a satisfactory or even sustained recovery, but it is heads above the revised 1.3 percent growth rate posted for the second quarter; it also reinforces the notion, shared by us, that the threat of a double dip recession is not imminent. Still, it is unclear if households are running on fumes that may soon evaporate. After all, the August spending increase occurred even as incomes were flat during the month, forcing households to dip further into savings, which slipped to a 4.5 percent rate from 4.7 percent in July. This is not sustainable behavior, especially since a substantial chunk was taken out of net worth in August by the woeful performance of the stock market, which didn't do much better in September. Clearly, households will need stronger evidence that job and income prospects are improving if they are to continue spending at even moderate rates in the fourth quarter. We'll get our first taste of evolving conditions in the labor market next week with the release of the September employment report. Expectations are understandably low but a surprisingly weak report could change a lot of perceptions about recession prospects, including ours. Stay tuned.

JPT093011-1514

Weekly Economic Commentary: Week of September 26

2011-09-26T10:13:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF SEPTEMBER 26, 2011

It was a week of shock and awe in the financial markets. The shock, of course, was emitted by the Federal Reserve, which announced on Wednesday that it was providing more accommodation to jump-start the flagging economy. The awe came afterwards, as the financial markets responded in a hellish fashion: stock prices in the U.S. and overseas markets plunged, reflecting a frenzied effort by global investors to dump all risky assets. This included gold, which had been the magnet for funds over the past year, as well as other commodities that now look too pricey in the midst of a slowing global economy possibly heading for a double-dip recession. If the markets expected support from a "Bernanke put", they were clearly disappointed to say the least.

To be sure, it would be unfair to blame the Fed entirely for the market turmoil on Wednesday and Thursday. Investors had plenty of anxiety-producing events to mull over. The sovereign debt crises continued to percolate with no resolution in sight. Greece is the focal point, of course, but concern is spreading that major banks in Europe are having funding problems, reminiscent of the months preceding the global financial crisis in 2008. The potential credit squeeze is reinforcing pressures that are already weighing heavily on the Continent; European economic growth appears to have come to a standstill in September, and manufacturing activity actually contracted according to some key gauges. The growth slowdown in the developed world is affecting emerging markets, as both China and India are reporting slowdowns in exports and overall activity. Emerging-market stock prices joined the downward parade in advanced markets. Indeed, the FTSE All-World index has slid 23 percent from its cyclical peak in May, putting the global markets squarely in bear territory - a decline of more than 20 percent.

While the hard data are certainly turning softer, the latest gyrations in financial markets may be more reflective of a crisis in confidence than of actual economic developments. Investors are clearly questioning whether political leaders in the U.S. and overseas have the will or ability to come to grips with the proliferating problems unfolding before them. European officials are openly divided over how to deal with the Greek debt issue that is spreading to Italy, Spain and other weaker members of the euro zone. In the U.S., the divisions are even more starkly revealed and embedded in partisan politics. Republicans want more budget cuts, Democrats want more stimulus and the president is becoming more of a lightening rod that is stiffening the resolve of the opposition parties.

The polarization is not only centered on fiscal matters, as the Federal Reserve is being attacked by both sides for what they are doing - and not doing. Again, Republicans want the Fed to stop easing policy further, claiming that past efforts have not yielded positive results and only sow the seeds of inflation. Presidential contender, Rick Perry, has described the actions of Fed chief Bernanke as … "almost treasonous". Harsh words indeed. Democrats, meanwhile, want the Fed to do more to jump-start growth, putting into effect a third round of quantitative easing if necessary. Absent any help from the fiscal side, which is handcuffed by deficit concerns and partisan politics, they view cranking up the money-printing press as the most viable alternative to get people and businesses to start spending and investing more.

It was under the glare of this hot spotlight that the Federal Reserve took action this week. At its two-day meeting that ended on Wednesday, the Fed announced that it is reshuffling its vast portfolio of securities, selling short-term Treasuries and swapping the proceeds into longer- term issues maturing from 6-30 years over the next eight months. The so-called "operation twist" did not come as a complete surprise as it was considered to be the most likely of the unconventional tools in the Fed's policy kit to be used. Still, the $400 billion size of the program exceeded expectations somewhat. But it is more of what the Fed said than what it did that may have unsettled the markets. In its statement following the two-day meeting, the Fed downgraded growth prospects even more than it had in its previous meeting on August 6, noting that there are "significant downside risks to the economic outlook, including strains in global financial markets." Not surprisingly, investors responded negatively to this gloomier outlook, which reinforced the steady drumbeat of downward forecast revisions of private economists in recent weeks.

Now the question is whether the Fed's renewed efforts to lower long-term rates will have any positive effect. As in everything else regarding policy outcomes, opinions are deeply divided. From a technical standpoint, one can argue that the when the demand for a security (or any product for that matter) increases, its price should also rise. Higher prices on bonds, of course, translate into lower yields. However, that analysis leaves out an important part of the equation, namely what happens on the supply side. If supply increases as much as demand, then the price effect should be neutral. Indeed, that's precisely why many believe the Fed's second round of quantitative easing, involving $600 billion of bond purchases from last November through June of this year had little or no effect. Simply put, the bond purchases were neutralized by an equal amount of new issuance by the Treasury, which has been relentlessly extending the maturity of its outstanding debt since 2008. In essence, the Treasury issued more long-term debt than the Fed purchased over the period.

The Treasury hasn't announced its financing plans going forward, but given the huge deficits it faces the odds are that a big chunk of the $400 billion of Fed purchases will be offset by bond issuance. But even if Operation Twist does marginally lower long-term rates, the next question is - so what? Clearly, the Fed hopes that lower rates will encourage households and businesses to borrow more, spurring increased spending, particularly for housing, and investment. But businesses have already built up a huge cash trove of over $2 trillion, equaling a record 7.1 percent of total assets, and have little incentive to borrow more in the face of sluggish demand prospects. Even if they do decide to lock in more borrowed funds at rock-bottom rates, there is no guarantee that they will spend the proceeds on capital goods or to expand payrolls, which is the ultimate objective of lowering interest rates.

To be sure, the overflowing coffers are being enjoyed mainly by large corporations that have access to the capital markets. Small businesses are not as fortunate, and many are still starved for funds to sustain operations. But this is something that is not easily rectified by the nudging down of long-term rates. Banks and other lenders are reluctant to take on risk in this environment, choosing instead to load up on Treasury securities or keep excess reserves at the central bank. Of course, part of the Fed's objective in lowering Treasury bond yields further is to flatten the yield curve, thus diluting the incentive of banks to purchase Treasury securities. The hope is that lenders will be prodded to take on more risk, including making loans to smaller businesses. Time will tell how this works out, but recent history is not encouraging.

But the main target of "Operation Twist" is arguably the moribund housing market, which continues to be one of the major impediments standing in the way of a more vigorous recovery. Here too, the odds of success are dubious at best. Keep in mind that mortgage rates are already at historic lows, standing at 4.09 percent in the latest week for 30-year fixed loans. Yet, the long slide in rates, which has lifted housing affordability measures to the highest level in decades, has had little effect in boosting home sales. Like small businesses, potential homebuyers are facing stringent lending standards that are shutting out all but the most creditworthy borrowers. The latter, in turn, are reluctant to commit to a home purchase for a variety of reasons, including anxiety over job and income prospects as well as expectations of a further downward spiral in housing values.

Indeed, buyers cancelled an exceptionally large 18 percent of contracts for existing home purchases in August, up from 16 percent in July, reflecting buyer remorse as well as overly conservative appraisals by banks. The good news is that existing home sales still edged up to 5.03 million units during the month, the highest selling pace since March 2009, from 4.67 million in July and may have come in even stronger if not for the harsh weather in the Northeast. Still, home sales are well below normal levels and prices continue to come under pressure from the mounting tide of foreclosures. Distressed sales accounted for a relatively large 31 percent of purchases during the month.

As if home sellers were not facing enough obstacles, the National Association of Realtors sees another problem that could stifle sales in coming months. According to the NAR, an extremely important issue currently is the renewal and availability of the National Flood Insurance Program, scheduled to expire at the end of this month. "About one out of 10 homes in this country need flood insurance to get a mortgage, and we would see significant negative market impacts without it," the trade group said in a statement accompanying the latest sales report. As is its wont, Congress is debating over whether to renew the program, and the sparks were still flying at the time of this writing.

Simply put, there are cogent reasons to be skeptical about whether the Fed's latest effort to stimulate growth will be successful. However, given the dire straits of the economy coupled with relatively low inflation, the potential benefit of adding an extra measure of accommodation outweighs the risk of doing nothing. Happily, the financial markets settled down on Friday, with stock prices actually posting small gains, both here and overseas. The first order of business is to eliminate the fear and uncertainty that have gripped investors in recent days. Hopefully, that will usher in some semblance of confidence that the global economy can weather the storms and avoid sliding into a recession. A confidence boost would be just what the policy doctors need to sustain the recovery. Time will tell.

JPT092611-1465

Weekly Economic Commentary: Week of September 19, 2011

2011-09-19T09:23:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF SEPTEMBER 19, 2011

It may be down, but don't count the economy out just yet. True, the "double-dippers" aren't exactly softening their tone about the dismal prospects they see in the months ahead. Indeed, the latest Wall Street Journal survey of economists, released Friday, revealed that one in three expects a downturn sometime over the next twelve months. If anything, recent data provide them with more ammunition to make their case. The month of August, for example, shaped up to be a lost cause, with zero growth in jobs and zero increase in retail sales. Absent job creation and consumer spending, the odds of the economy escaping a downturn shrivel faster than the favorable poll numbers for the denizens on Capitol Hill and the White House.

But August was a pretty cruel month for a variety of reasons, not all of which are related to economic fundamentals. Both Main Street and Wall Street had to cope with a particularly vicious battle over the debt ceiling, which evinced a hopeless feeling that no one was in charge of the economic ship. As much as anything, that perception sent consumer confidence reeling and provoked both small and large companies to delay hiring and spending plans. And while Washington dithered, Europe appeared to be going up in flames; the long-simmering Greek debt crisis erupted once again, threatening serious damage to major European banks if not the fate of the European Union itself. Comparisons with the 2008 financial crisis grabbed headlines, which only reinforced the wild gyrations in the financial markets. It was a particularly brutal month for stock prices, which lost more than 6 percent during the period after recovering from a much deeper loss over the first three weeks of the month. . Even Mother Nature played a role, as Hurricane Irene wreaked havoc with business operations and spending in the final days of the month.

So to some extent the dismal results for the dog days of August could be forgiven. But the markets are anything but forgiving, and if a sense of doom and gloom persists it will be a rough road ahead for investors. That said, the stock market turned in a positive performance this week, recording only the second weekly gain in two months. Rather than turning on improving economic prospects, the modest rally probably reflected a sense of relief that European leaders were moving more aggressively to contain the Greek debt crisis, including coordinated action by five central banks to provide an unlimited volume of dollar funds to European banks over the next three months. The action essentially buys time for European finance ministers to devise a longer-term solution for an ongoing sovereign debt problem that seems as intractable as ever. Time will tell if that objective is successful, but there is a widespread perception that the European leaders still lack a sense of urgency to come to grips with the issue.

From our lens, there is a silver lining in the dark clouds that engulfed the economy in August. While not entirely convinced that external shocks were solely to blame, there is something to be said for the argument that things could have been considerably worse. Take the retail sales report released this week. True, the absence of any spending increase during the month is certainly a cause for alarm, particularly given the outsized role that consumers play in the overall economic picture. But households were clearly rattled by the barrage of shocks during the month, manifested by the plunge in confidence to the lowest level since the 2008 financial crisis. From that perspective, it is encouraging that retail merchants did not suffer an actual decline in sales. To be sure, some did, including department stores and clothing outlets, suggesting that back-to-school shopping was soft. But those setbacks may have reflected the effects of Hurricane Irene as well, which should be reversed this month.

As it is, the flat reading for retail sales in August means that consumers did not take back the modest gains made in June and July. Compared to a year ago, sales are still up by a respectable 7.3 percent. Granted, a rebound in auto sales this year made a hefty contribution to the increase, although car sales slipped a bit in August. Perhaps a better perspective is to look at what analysts refer to as core sales, which excludes highly volatile or price-driven sales of such products as autos and gasoline. Here the picture is one of steady, albeit certainly not robust, gains. In August, core sales posted its eighth consecutive monthly increase, rising by 0.1 percent. While the increase was slim, it pushed the year-over-year increase to 5.5 percent, which is considered healthy for this stage of a recovery.

Keep in mind too that retail sales account for only about a third of total consumer expenditures, as services comprise the lion's share of the total. A more complete snapshot of consumption will not be available until later this month, when the Commerce Department releases figures on personal income and outlays for August. But the July reading was solid and barring an unexpected collapse in spending on services in August, consumers are on pace for about a 2 percent increase in the third quarter. That's certainly nothing to brag about, but it would provide enough ballast to keep the economy growing, perhaps in the neighborhood of a 2.5 percent annual rate during the period. That would not preclude the onset of a double-dip recession, but its presence would not be seen until at least later in the year.

And while the demand side of the economic equation is lacking heft, the output side is picking up some of the slack. Industrial production in August rose by 0.2 percent, building on the torrid 0.9 percent increase in July. As the chart shows, industrial output has been the little engine that could throughout most of the recovery, restoring about half of the unprecedented losses suffered during the Great Recession. There's still a long hill to climb, but the August level is the highest since August 2008. What's more, last month's increase was held back by a large 3.0 percent drop in utility output, reflecting widespread power outages caused by Hurricane Irene for several days. Manufacturing output rose by a solid 0.5 percent, almost matching the 0.6 percent increase in July. Automakers continue to make up for the down time caused by the supply disruption associated with the Japanese earthquake last spring. But the gains were widespread across most major manufacturing groups.

The output spurt in August was one of the few upside surprises among the array of data released in recent weeks. Expectations were for a much weaker increase or none at all since the August jobs report showed that hours worked in the manufacturing sector slipped along with manufacturing payrolls. Hence, either productivity increased or the estimate of manufacturing jobs will be revised up in the next employment report. Either way, the implications for the economy are positive. What's more, Hurricane Irene will spur rebuilding efforts along the east coast, which should give a near-term boost to the production of construction supplies and materials. Even more important, it will provide some much-needed jobs for an army of unemployed construction workers. On the negative side, the robust gains in exports this year - a major contributor to the rebound in manufacturing output - should wane in the face of slowing growth overseas.

The bottom line is that the economy is still expanding, but whether there is enough momentum to sustain growth without some additional help from policy makers is debatable. Clearly the risk of a double-dip recession has increased in recent months, if only because the fear of a renewed downturn has spread and threatens to become a self-fulfilling prophecy. The greater the fear, the more likely it is that households and businesses will alter their behavior in ways that are damaging to growth. But a few weeks of positive news - or even the absence of additional shocks - could allay some of those fears and unlock some positive impulses that could jump-start spending and hiring. Certainly, there are a multitude of prospects in coming weeks that could tip the scales in either direction. The finance ministers of the euro zone are meeting in Poland this weekend; while no major action is expected, a pledge of solidarity or at least a strong commitment to help weaker members of the EU meet their debt obligations would send a positive message to the financial markets. Just the opposite would result if dissent and discord continue to be the highlight of the meeting.

On Monday, president Obama is scheduled to provide more details on his recently-proposed $447 billion jobs bill. As is the case with the European finance ministers meeting in Poland, the U.S. legislature is a caldron of divisive politicians that lowers the odds of anything constructive happening in the way of fiscal stimulus. At most, we suspect that about half of the president's proposals will be approved, primarily the tax incentives already in place as well as an extension of jobless benefits for the long-term unemployed. These seem to be the most likely to gain bipartisan acceptance, although there is broad support for some sort of infrastructure spending. We will consider it a policy victory if Congress is able to short-circuit the fiscal drag that would otherwise impede the recovery if nothing were done.

That leaves our old friend, Ben Bernanke, and his merry band of supporters to provide whatever heavy lifting policy will offer in coming months. There's been more than the usual amount of speculation surrounding next week's policy-setting meeting, with as many pundits expecting the Fed to push another one of its policy levers as there are those expecting the Fed to stand pat. Among those expecting some action, the most likely vehicle is a variation of "operation twist", with the Fed extending the maturity of its $2.6 trillion portfolio of government and mortgage securities. The objective of such a move would be to lower long-term interest rates while keeping short-term rates anchored at their near-zero level.

We are agnostic over the prospects of such a move. Charlie Evans, the president of the Federal Reserve Bank of Chicago, made a compelling case for additional monetary easing last week when he noted that unemployment is a far greater problem than is inflation. However, the hawks on the FOMC committee may feel more emboldened in taking a harder stance against further easing based on the latest inflation report. This week, the Labor Department reported that the consumer price index registered another sizeable 0.4 percent increase in August, lifting the year-over-year gain to 3.8 percent. The core CPI, which excludes the volatile food and energy prices, rose by a more modest 0.2 percent last month but the 12-month increase has risen to 2 percent. Not only is that the fastest core inflation rate since November 2008, it is getting uncomfortably close to the Fed's upper tolerance limit. Clearly, the doves and the hawks will be having a lively debate at the upcoming two-day meeting on Tuesday and Wednesday.

JPT091611-1449

Weekly Economic Commentary: Week of September 12, 2011

2011-09-12T08:24:00.000-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF SEPTEMBER 12, 2011

Bring out the heavy artillery! That’s the message delivered by President Obama and Fed chief Bernanke this week, hoping to provide the moribund U.S. economy with a double-dose of fiscal and monetary stimulus. To be sure, Bernanke’s tone was much more muted than Obama’s and the monetary aid hinted at in his talk before the Economic Club of Minnesota this week contained far fewer specifics. Essentially, the chairman reaffirmed the essence of his August 26 Jackson Hole comments, noting that the Fed has the tools available to inject more stimulus into the economy. The one disappointment to the financial markets was that he failed to provide more specific guidance as to what form the stimulus would take.

But the tone of Bernanke’s remarks this week left us with a stronger impression that some further monetary easing would be adopted at the upcoming two-day policy meeting on September 20-21. In his concluding comment, for example, he noted … “the Federal Reserve will certainly do all that it can to help restore high rates of growth and employment in a context of price stability”. That’s a stronger promise of more action than was delivered on August 26, although it was skimpier on specifics. Why the stronger message? Two reasons: First, the Fed has since received an array of fresh data depicting a much weaker economy than was available in late August. These included a tepid GDP report, revealing near-stagnant growth in the first half of the year, plunging consumer confidence and, perhaps most important, the latest employment report with its shocking headline that no jobs were created in August. Second, Bernanke’s well-known bias for more accommodation has recently been supported by sympathetic comments from several Fed officials, including Chicago’s Fed president Charles Evans this week. Our sense is that the doves on the Fed will put the full-court press on the hawks at the upcoming FOMC meeting to provide more accommodation.

That said, the economic benefits of additional pump-priming by the Fed is highly debatable, and it’s doubtful if anything with the punch associated with QE1 or QE2 will come out of the meeting. However, in combination with more fiscal stimulus, the reinforced impact could be formidable. Not surprisingly, Obama’s speech on Thursday night took center stage, and the proposed $447 billion job creation bill was a heftier package than expected. We suspect that it would have had a positive affect on the financial markets on Friday had it not been overwhelmed by escalating fears surrounding the European debt woes during the day. Make no mistake, it would be foolhardy to get overly optimistic about the president’s program, as it still must overcome opposition that is likely to emerge in Congress before becoming law. Still, that opposition should be far less acrimonious than the political debate associated with the debt-ceiling debacle. Indeed, Republicans are sounding a conciliatory note, acknowledging that there were several promising elements in the bill that they could work with.

What’s more, although the $447 billion program is larger than what had been expected, a good portion of it simply extends the stimulus put in place earlier this year, such as an extension of unemployment benefits and the employee payroll tax cuts. Hence, the incremental thrust to the economy is less than what is implied by the size of the package. Keep in mind too that the size of the program could well be altered as it wends its way through the legislative process, and the odds favor a smaller over a larger bill in the final version. Still, assuming that something of substance does come out of Capitol Hill in coming weeks, there are reasons to be more optimistic about the outlook than was the case a few weeks ago. Even the most skeptical economists see positive benefits on the margin, with several well-known forecasters upping their growth estimate for 2012 by 1 – 1 ½ percentage points.

And while there is even more uncertainty over how many jobs would actually be created, here too the positives outweigh the negative perceptions. Some believe that the impact would be negligible, but more see a sizeable jolt to employment, resulting in as many as 1.5 – 2.0 million net new jobs than would otherwise occur. There is much at stake, of course, both for the economy and for politicians. For the economy, it could provide just enough of a cushion that prevents the U.S. from sliding into a double-dip recession. For politicians, particularly the president, it could make the difference between a second term or a Carter-like exit from the Oval Office. If nothing is done, or the bill is watered down substantially, opponents could well be punished by the voters as obstructionists, particularly if the economy continues to deteriorate leading up to the 2012 election.

From our lens, the economy needs as much help as it can get. While we believe the odds of a double-dip recession remain below 50-50, the risk of another downturn has increased in recent months. Historically, a growth slowdown of the magnitude seen over the past two quarters as well as the climb in the unemployment rate over the past several months have foreshadowed a recession. Given the transitory shocks that have contributed to the bad tidings, however, the historical precedent should be discounted somewhat. Incoming data, while not particularly robust, do point to a modest acceleration in growth in the third quarter. Consumer spending in July came in stronger than expected and the trade deficit narrowed considerably during the month. Indeed, the government reported that the trade gap plunged to $44.8 billion during the month from $51.6 billion in June, a much greater drop than expected. Over the first half of the year, the deficit subtracted about a quarter-percent from the economy’s growth rate; the July shrinkage, assuming it is not unexpectedly reversed in August, indicates that trade will make a positive contribution to growth in the current quarter.

But the economy still lacks enough momentum to assure that the recovery will be sustained. What history also tells us is that recoveries following a severe banking crisis, such as the one witnessed in 2008, tend to be much weaker than the upturns following a garden-variety recession. The wounds take longer to heal, and the healing process retards growth. The most visible scar in the current instance is the debilitating hit to household finances that occurred when the real estate bubble deflated; that extinguished trillions of dollars in home equity, even as mortgage and other debt piled up during the bubble years remain an albatross around the necks of households. The process of reducing debt has been underway for the past two years; as long as it continues, consumers will be purchasing fewer goods and services than would otherwise be the case. More than anything, the deleveraging effort has been a critical drag on the economy. While considerable progress has been made, ongoing efforts to repair damaged balance sheet and restore net worth should remain a headwind over the foreseeable future.

By itself, the long healing process should not bring the curtain down on the recovery. The pattern of recoveries following a financial crisis is that they take longer to build up a head of steam, but they usually do no not expire before their time. However, the environment in which the current recovery is unfolding is fraught with so many threats and potential shocks that it is impossible to discount the prospect of a double-dip recession. As noted earlier, the European debt crisis that hammered the stock market on Friday continues to weigh heavily on the minds of investors. While the financial system in the U.S. has been restored to health for the most part, European banks remain highly exposed to dodgy debt of weak sovereign nations, headlined by Greece and relentlessly expanding to Italy and Spain. The fear is that the ECB and the leaders of the European Union are far behind the curve in dealing with the problem, heightening the risk that another Lehman-type credit crisis is in the making. Given the global interconnectedness of financial institutions, the U.S. would not be immune from a banking crisis spawned on the Continent.

With stocks plunging on Friday, extending months of highly volatile activity, investor confidence is once again coming under attack. This poses another threat to the recovery, as volatile markets reinforce other influences that have undermined household and business confidence. Indeed, the latest reading from the Conference Board revealed that consumer confidence in August recorded one of the steepest monthly declines on record. Its index sank to 44.5, which is not far from the all-time low reached during the height of the financial crisis in 2008. To be sure, consumers were battered by an unprecedented number of shocks last month, including the debt-ceiling debacle, the European debt crisis and tragic floods as well as heavy rainstorms throughout a broad swath of the nation. This month has not exactly been a sea of tranquility either, starting with Hurricane Irene and now the renewed European debt flare-up. But transitory shocks can quickly fade in the minds of households, causing no lasting change in behavior.

A more fundamental impact happens when confidence is eroded by a perceived deterioration in economic conditions. This is the current threat that we deem to be more challenging. With the dismal jobs report released last week, households are clearly suffering from a ramped up anxiety over employment prospects. Recent polls show that they have become much more downbeat about the labor market over the next six months, and an exceptionally high percentage do not believe their incomes will rise over the period. Admittedly, these polls as well as consumer confidence surveys are relatively poor predictors of consumer spending; but when spirits get this low and the surrounding environment is as fraught with uncertainty as is currently the case, it is hard to see households rushing to the malls and shopping centers to allay their fears.

If nothing else, therefore, the president’s job creation bill should provide some hope that conditions will not deteriorate further. Keep in mind that fiscal policy was set to exert a considerable drag on the economy next year if the provisions of the 2010 stimulus bill were allowed to expire as scheduled. With the economy already struggling, that additional drag could well be the tipping point, pushing the nation into another recession. The president’s proposal extends those provisions and adds about another $250 billion in tax relief, special hiring incentives, aid to state and local governments and infrastructure spending. To be sure, what the bill provides in 2012 will be phased out in 2013 and 2014, when fiscal policy will again turn into a drag on growth.

The hope is, however, that by then the private sector will be sufficiently energized so that the recovery can withstand the fiscal withdrawal. That remains to be seen, of course, as much will depend on the extent of job creation that actually occurs next year. While there is much to admire in the president’s jobs package, it is noteworthy that virtually nothing was proposed to help the ailing housing industry, which remains one of the heaviest weights on the recovery. There may be some merit to the argument that market forces should be allowed to clear the housing sector of its excesses. But without a housing recovery, the economy will still not be running on all of its key cylinders, undermining the potential increase in jobs and the pace of economic growth.

JPT090911-1405

Weekly Economic Commentary: Week of September 5

2011-09-06T08:41:00.001-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF SEPTEMBER 5, 2011

The Labor Day weekend did not bring good news for American workers. On Friday, the Labor Department reported that the U.S. economy failed to generate any net new jobs in August for the first time since last September. To be sure, expectations for the month were low to begin with, as company hiring plans were undoubtedly dampened by the raging debate over the debt ceiling as well as the intensification of the European debt crisis. Still the job report was even weaker than expected, and the underlying details were not much better. There were some quirky elements that made the headline number overstate weakness: 45 thousand Verizon workers were on strike, and hence not counted as employed, and the payroll count in the auto industry was skewed by seasonal disruptions in production schedules caused by the Japanese earthquake and tsunami. And while the household survey painted a less dismal picture than the establishment survey, the unemployment rate remained at an elevated 9.1 percent, the same as July.

The weak jobs report puts more pressure on the Federal Reserve to do something and heightens interest on what president Obama will propose in his Congressional address on Thursday to promote job growth. Our sense is that the Fed will refrain from taking action at its upcoming policy meeting on September 20-21 based on the August jobs numbers, as some other data portrayed a stronger picture for the third quarter; consumer spending in July was surprisingly robust and chain stores are reporting brisk back-to-school sales. Besides, several members of the Fed are firmly opposed to further monetary accommodation, believing that it would provide little, if any, benefit to the economy. However, chairman Bernanke is known to advocate some form of additional monetary stimulus; if the economy continues to sputter for another month or so and Washington fails to provide any near-term help to boost growth, the Fed will likely provide additional policy support again during the fall.

This is an abbreviated version of the commentary due to the Labor Day holiday. Below is an updated table of key monetary and economic data for the latest week as well as a repeat of last week’s commentary. We will present a full commentary this coming Friday, September 9.

Between an earthquake registering 5.8 in Virginia and Hurricane Irene barreling up the East Coast, there certainly were enough shocks to fill headlines this week. And not surprisingly, folks in those respective areas responded with their usual resilience, dealing with the disturbances as best they can and getting on with their lives. The question is, does the U.S. economy have that kind of resilience to withstand a shock, given its weakened state and remote chance of any near-term policy remedies. Both of those conditions were in full view this week.

To be sure, the weakened economic backdrop has been clearly visible for some time. But Friday’s revised data on second-quarter GDP portray an even weaker condition during the period than estimated a month ago. Instead of posting a tepid growth rate of 1.3 percent, the revised figures put the quarterly growth rate at a mere 1 percent annual rate. Combined with the negligible 0.4 percent pace in the first quarter, the economy limped ahead at a lackluster 0.7 percent annual rate over the first half of the year. Simply put, the recovery is getting ever-closer to the stall speed that an increasing number of economists believe will eventually morph into a double-dip recession. Like an aircraft when its engine sputters to a near halt, the inevitable result is that it hurtles to the ground. Is the U.S economy in danger of a similar free-fall?

By at least one measure – the year-over-year growth rate in GDP – the recovery is already in uncharted waters. With the downward revision, gross domestic product stood a measly 1.5 percent above its level of a year earlier. Only once before has the annual growth rate been so perilously close to zero during a recovery without leading to a recession within a few months. That was in the fourth quarter of 2003, two years into an upturn that also started very slowly. However, the growth engine quickly revved up, ignited by the Bush tax cuts and swift interest rate reductions that contributed to the ill-fated housing boom. Neither of those catalysts is poised to provide a spark this time. Additional fiscal stimulus is handcuffed by deficit concerns, and the Fed has lowered interest rates as far as they can go. But instead of responding positively to low rates, the housing market is still reeling from weak sales, falling home prices and a rising tide of foreclosures.

That’s why there had been so much speculation about what Ben Bernanke’s would say at the Jackson Hole, symposium this Friday. Recall that the Fed chief sent a thunderbolt through the financial markets at the previous annual gathering of this highly popular event last August. At the time, he indicated a new round of bond-purchases, or QE2, would soon be implemented, which eventually materialized three months later. The message sent bond yields tumbling and lit a spark under the stock market, ushering in a major rally that lasted for another six months or so. Many attribute Bernanke’s speech last August 27 as the game-changer that breathed new life into what then also appeared to be a faltering recovery. This time, however, Bernanke provided no new program that promises to propel the economy out of its soft patch.

Instead, the Fed chairman reiterated his concern about the economy’s subpar performance, which he expects to continue in coming quarters, and noted that monetary policy alone cannot propel the recovery forward. Specifically, he said, "Most of the economic policies that support robust economic growth in the long run are outside of the province of the central bank. We have heard a great deal lately about federal fiscal policy in the United States, so I will close with some thoughts on that topic, focusing on the role of fiscal policy in promoting stability and growth." Bernanke urged that, "US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time." What’s more, "Fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery." In other words, stay the course on reducing the deficit over the longer term, but don’t impose overly harsh cuts in the near term that could do more harm than good.

Nonetheless, the Chairman noted that the FOMC is actively considering policy alternatives for providing additional stimulus. While he didn’t specify what those alternatives are, they were spelled out at his July 13 semiannual monetary policy testimony. Recall, Bernanke then outlined three options for the Fed to use if further accommodation was needed. He said, "We have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally. Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs. However, prudent planning requires that we evaluate the efficacy of these and other potential alternatives for deploying additional stimulus if conditions warrant."

At the August 9 FOMC meeting, the Fed chose to use the first option immediately, stating explicitly that short-term rates would be kept at the current, near-zero level at least through the middle of 2013. In the days leading up to the Jackson Hole speech, however, there was some speculation that Bernanke would pull another stimulus rabbit out of his hat, perhaps hinting at a third round of quantitative easing. The fact that he didn’t should not come as a surprise and, indeed, the stock market rebounded after a knee-jerk selloff immediately following the speech. Keep in mind that there are significant differences between the current environment and that of a year ago. Most importantly, in August of 2010 both inflation and inflationary expectations were falling. Combined with the downshifting in economic growth, the Fed believed that deflation was a real risk, providing a compelling reason to act boldly.

Currently, the case for QE3 is less compelling. True, the economy is even weaker now than it was then. But at least some of the weakness has been due to transitory forces, which are now easing. The jump in auto assemblies in July, which had been depressed by the lack of parts due to the Japanese earthquake and tsunami, gave a big boost to industrial production last month. Similarly, the spurt in oil prices associated with the uprising in Libya during the spring and early summer has since been reversed. With Libyan oil production likely to come back on stream in coming months, the easing of oil prices could well continue and put more discretionary cash in the pockets of consumers. Admittedly, these transitory forces did not contribute as much to the slowdown during the first half of the year as originally thought. But on the margin, their unwinding should provide some impetus to growth as the second half unfolds.

Make no mistake; the near-term outlook is still very murky. At best, the economy will grow just fast enough to keep the unemployment rate from rising, but not enough to restore a significant fraction of the 8.5 million jobs lost during the recession. Until the labor market improves more meaningfully, consumer confidence is likely to remain depressed and put a lid on spending. Over the foreseeable future, households will be focused more on reducing debt and repairing balance sheets than on acquiring discretionary goods and services. Any unexpected shock that would further undermine confidence could well force a more severe retrenchment. The risk that the recovery will peter out is still remote, but not insignificant.

The Fed is betting that the economy will remain on a positive growth track and even gather some momentum over the second half of the year, although it did downgrade its growth forecast for the period. Despite the prospect of a subpar performance for some time to come, the big difference between now and last year that precludes another round of quantitative easing, at least right away, is the inflation backdrop. As noted, inflation was receding in 2010. Now it is accelerating. Indeed, while the latest revision to GDP pulled down growth for the second quarter, it simultaneously revised up inflation. The core personal consumption deflator, which the Fed monitors very closely, was revised to show a 2.2 percent increase during the period, up from an original estimate of 2.1 percent. That’s the strongest inflation rate since the fourth quarter of 2009. In the fourth quarter of 2010, when Bernanke unveiled QE2, the core PCE deflator was increasing at a 0.7 percent pace. Other inflation measures, such as the CPI, have also kicked up this year.

That’s not to rule out the possibility the Fed may yet pull the plug on further monetary action. At his Jackson Hole speech, Bernanke did reveal his plan to lengthen the next FOMC meeting in late September from one day to two, to “allow a fuller discussion”. Since that’s less than a month away, it’s unlikely that conditions will have changed enough by then to spur major move. However, if incoming data and anecdotal reports continue to point to further weakness, the trigger for some action may not be far off. Chances are, the next move would be to use the second option outlined in Bernanke’s congressional testimony, namely to increase the duration or maturity of portfolio holdings, sort of a “light operation twist” to further reduce long term rates. Another bond purchase program does not seem to be a viable option, given the political climate and strong aversion to such a move by some members of the Fed itself.

The odds that the September FOMC meeting will be receptive to a portfolio adjustment should be quite high. For one, the August jobs report, scheduled for next Friday, is expected to be weak, reflecting in part the Verizon strike, which idled some 45 thousand workers. For another, Bernanke has recently expressed deep concern about the weak housing market, which he views as a key missing link in the current recovery. Although the Fed has limited options to bolster housing activity, keeping mortgage rates lower than otherwise would certainly be a positive influence. If the latest housing data are any indication, the Fed will be highly motivated to do just that. Last week we reported the dismal state of homebuilding activity. This week, the Commerce Department released its latest numbers on new home sales, and the picture does not get any brighter. Sales in July fell to a 298 thousand annual rate, following downward revisions to the prior three months, hitting the lowest level since February when record snowstorms depressed activity.

JPT090211-1379

Weekly Economic Commentary: Week of August 29

2011-08-29T10:34:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF AUGUST 29, 2011

Between an earthquake registering 5.8 in Virginia and Hurricane Irene barreling up the east coast, there certainly were enough shocks to fill headlines this week. And not surprisingly, folks in those respective areas responded with their usual resilience, dealing with the disturbances as best they can and getting on with their lives. The question is, does the U.S. economy have that kind of resilience to withstand a shock, given its weakened state and remote chance of any near-term policy remedies. Both of those conditions were in full view this week.

To be sure, the weakened economic backdrop has been clearly visible for some time. But Friday's revised data on second-quarter GDP portray an even weaker condition during the period than estimated a month ago. Instead of posting a tepid growth rate of 1.3 percent, the revised figures put the quarterly growth rate at a mere 1 percent annual rate. Combined with the negligible 0.4 percent pace in the first quarter, the economy limped ahead at a lackluster 0.7 percent annual rate over the first half of the year. Simply put, the recovery is getting ever-closer to the stall speed that an increasing number of economists believe will eventually morph into a double-dip recession. Like an aircraft when its engine sputters to a near halt, the inevitable result is that it hurtles to the ground. Is the U.S economy in danger of a similar free-fall?

By at least one measure - the year-over-year growth rate in GDP - the recovery is already in uncharted waters. With the downward revision, gross domestic product stood a measly 1.5 percent above its level of a year earlier. Only once before has the annual growth rate been so perilously close to zero during a recovery without leading to a recession within a few months. That was in the fourth quarter of 2003, two years into an upturn that also started very slowly. However, the growth engine quickly revved up, ignited by the Bush tax cuts and swift interest rate reductions that contributed to the ill-fated housing boom. Neither of those catalysts is poised to provide a spark this time. Additional fiscal stimulus is handcuffed by deficit concerns, and the Fed has lowered interest rates as far as they can go. But instead of responding positively to low rates, the housing market is still reeling from weak sales, falling home prices and a rising tide of foreclosures.

That's why there had been so much speculation about what Ben Bernanke's would say at the Jackson Hole, symposium this Friday. Recall that the Fed chief sent a thunderbolt through the financial markets at the previous annual gathering of this highly popular event last August. At the time, he indicated a new round of bond-purchases, or QE2, would soon be implemented, which eventually materialized three months later. The message sent bond yields tumbling and lit a spark under the stock market, ushering in a major rally that lasted for another six months or so. Many attribute Bernanke's speech last August 27 as the game-changer that breathed new life into what then also appeared to be a faltering recovery. This time, however, Bernanke provided no new program that promises to propel the economy out of its soft patch.

Instead, the Fed chairman reiterated his concern about the economy's subpar performance, which he expects to continue in coming quarters, and noted that monetary policy alone cannot propel the recovery forward. Specifically, he said, "Most of the economic policies that support robust economic growth in the long run are outside of the province of the central bank. We have heard a great deal lately about federal fiscal policy in the United States, so I will close with some thoughts on that topic, focusing on the role of fiscal policy in promoting stability and growth." Bernanke urged that, "US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time." What's more, "Fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery." In other words, stay the course on reducing the deficit over the longer term, but don't impose overly harsh cuts in the near term that could do more harm than good.

Nonetheless, the Chairman noted that the FOMC is actively considering policy alternatives for providing additional stimulus. While he didn't specify what those alternatives are, they were spelled out at his July 13 semiannual monetary policy testimony. Recall, Bernanke then outlined three options for the Fed to use if further accommodation was needed. He said, "We have a number of ways in which we could act to ease financial conditions further. One option would be to provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels. Another approach would be to initiate more securities purchases or to increase the average maturity of our holdings. The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally. Of course, our experience with these policies remains relatively limited, and employing them would entail potential risks and costs. However, prudent planning requires that we evaluate the efficacy of these and other potential alternatives for deploying additional stimulus if conditions warrant."

At the August 9 FOMC meeting, the Fed chose to use the first option immediately, stating explicitly that short-term rates would be kept at the current, near-zero level at least through the middle of 2013. In the days leading up to the Jackson Hole speech, however, there was some speculation that Bernanke would pull another stimulus rabbit out of his hat, perhaps hinting at a third round of quantitative easing. The fact that he didn't should not come as a surprise and, indeed, the stock market rebounded after a knee-jerk selloff immediately following the speech. Keep in mind that there are significant differences between the current environment and that of a year ago. Most importantly, in August of 2010 both inflation and inflationary expectations were falling. Combined with the downshifting in economic growth, the Fed believed that deflation was a real risk, providing a compelling reason to act boldly.

The Fed is betting that the economy will remain on a positive growth track and even gather some momentum over the second half of the year, although it did downgrade its growth forecast for the period. Despite the prospect of a subpar performance for some time to come, the big difference between now and last year that precludes another round of quantitative easing, at least right away, is the inflation backdrop. As noted, inflation was receding in 2010. Now it is accelerating. Indeed, while the latest revision to GDP pulled down growth for the second quarter, it simultaneously revised up inflation. The core personal consumption deflator, which the Fed monitors very closely, was revised to show a 2.2 percent increase during the period, up from an original estimate of 2.1 percent. That's the strongest inflation rate since the fourth quarter of 2009. In the fourth quarter of 2010, when Bernanke unveiled QE2, the core PCE deflator was increasing at a 0.7 percent pace. Other inflation measures, such as the CPI, have also kicked up this year.

That's not to rule out the possibility the Fed may yet pull the plug on further monetary action. At his Jackson Hole speech, Bernanke did reveal his plan to lengthen the next FOMC meeting in late September from one day to two, to "allow a fuller discussion". Since that's less than a month away, it's unlikely that conditions will have changed enough by then to spur major move. However, if incoming data and anecdotal reports continue to point to further weakness, the trigger for some action may not be far off. Chances are, the next move would be to use the second option outlined in Bernanke's congressional testimony, namely to increase the duration or maturity of portfolio holdings, sort of a "light operation twist" to further reduce long term rates. Another bond purchase program does not seem to be a viable option, given the political climate and strong aversion to such a move by some members of the Fed itself.

JPT082611-1332

Weekly Economic Commentary: Week of August 22

2011-08-22T08:39:00.000-04:00

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF AUGUST 22, 2011

Are we witnessing a stealth QE3? In a stunning development, the bellwether 10-year Treasury yield plunged to under 2 percent at one point this Thursday, the lowest in at least fifty years, before edging back up to 2.06 percent on Friday. What's remarkable about the persistent decline in long-term rates - the 10 year ended last week at 2.24 percent and has been on a downtrend since last April - is that it is occurring without the Fed revving up the printing presses, as was the case with QE1 and QE2. Recall that the objective of the bond-purchase programs initiated in 2009 and 2010, which ended this June, was to apply downward pressure on bond rates with the aim of stimulating housing activity, business investment and, ultimately, overall economic growth. But the steep rate drop this week was accomplished without the Fed having to expand its balance sheet - something that would have met stiff resistance in any case, both from within and outside the corridors of that beleaguered institution.

However, unlike the experience accompanying QE1 and QE2, the stock market this time has not responded as favorably to the decline in bond yields. Instead of surging on a wave of optimism that monetary stimulus and lower bond yields would ramp up the economy's growth engine and bring in a flood of new profits, as was the case in 2009 and 2010, the stock market has endured the wildest swings since the recession, with the bad days outnumbering the good ones. Since reaching a nearby peak in late April, the major stock indexes are down by 15-20 percent, approaching bear market territory. Why the extreme volatility highlighted by bouts of gloom and doom?

There are no easy answers to this question, of course. But since investor confidence peaked last spring, there has been a barrage of developments that would buffet even the most wild-eyed optimist. On the macro level, the economy has morphed from a hopeful recovery into a "growth recession" that sputtered towards stall-speed over the first half of the year. As many optimists as there were about the recovery's prospects earlier in the year, there are now about as many pessimists who believe the next phase of the cycle will be a double-dip recession. Stock prices are a leading, if often misleading, indicator of economic developments, so the swoon in prices may well be discounting the next economic downturn.

Still, shifts in investor perceptions about the economy rarely generate the extreme volatility seen in recent weeks. When turmoil grips the financial markets, it is usually the result of shocks that are either unexpected or more intense than investors can tolerate. There has been no shortage of market-rattling lightening bolts over the past month or so. Most analysts would probably finger the S&P downgrade of U.S. debt as the trigger that set off the latest bout of gyrations, although the machinations in Washington underpinning the debt-ceiling debacle played a major role. But whatever ramifications associated with Washington's inability to come to grips with its intractable debt problems, they were quickly overshadowed by even greater concerns over the long-simmering European debt problems.

The sovereign debt imbroglio has reached a boiling point in recent weeks, and more than a handful of analysts see portents that resemble the events leading up to the global financial crisis in 2008. Indeed, by googling the phrase "sovereign debt and Lehman Brothers", nearly 200 thousand references appear over the past month alone. Nothing is more threatening to the global economy and financial markets than a seizing up of the credit system like that which occurred following the Lehman collapse in September 2008. Banks wouldn't lend to each other and the credit spigot closed for virtually everyone, choking off the lifeblood that nurtures all economic activity. Needless to say, the health of major European banks is coming under close scrutiny by European leaders as well as the financial markets, worried that the balance sheets of these institutions are too heavily exposed to the debt of weaker members of the European Union.

Even the Federal Reserve Bank of New York has gotten into the act. According to reliable sources, the N.Y. Fed has been holding meetings with executives of large European banks operating in the U.S. The Fed is apparently concerned about the day-to-day liquidity of these banks, particularly if their parent company overseas has to tap into their cash hoard to meet their own funding requirements. As the chart shows, foreign-owned banks in the U.S. have built up a huge trove of cash assets, parked at the Federal Reserve, over the past year, thanks largely to the massive liquidity injections provided by the Fed in the form of QE1 and QE2. Between December 15, 2010 and June 8 of this year, cash assets at these institutions soared from $310 billion to $957 million.

Most, but not all, if these assets are held by large European banks, which are now experiencing balance sheet strains, reflecting their exposure to wobbly sovereign debt. One undisclosed bank this week turned to the European Central Bank to borrow $500 million in emergency funds, sparking additional fears of a liquidity problem. What may also be getting the Fed's attention is the abrupt drawdown of foreign bank cash in recent weeks. On August 3, cash assets had shrunk to $758 billion, a drop of $200 billion, or 21 percent, from the peak on June 8. As the chart shows, that's still more than double the cash pile held before the huge runup began last December, but the direction is palpable. We will have to monitor spreads in the Eurodollar and Libor markets to gauge the intensity of pressures that might accompany a further liquidity squeeze at foreign banks. So far, the pressures are not alarming, but if speculators get a whiff of a crisis, they could well contribute to its onset.

Which brings us back to the precipitous drop in U.S. Treasury yields that has been unfolding for several months. What it boils down to essentially is that as bad as the debt situation is in the U.S., it's even worse overseas. What's more, U.S. banks are collectively in much better shape than their European counterparts, having built up more capital and retaining a healthier asset mix, notwithstanding the still-burdensome holdings of troubled mortgage loans. More to the point is that investors, both foreign and domestic, still view dollar-denominated U.S. Treasury securities as a critical safe haven to park funds in times of turmoil and uncertainty about economic conditions. Look no further to understand why bond yields have retreated so far - most everything else, except gold and other precious metals, do not feel safe.

But the drop in yields also reflects another distressing influence, namely the downgrading of U.S. growth prospects, including the conspicuous rise in recession fears. From our lens, the odds that the economy will suffer a double-dip recession are still less than 50-50 unless the European debt crisis does indeed spread to the U.S. financial system, which is unlikely for the reasons noted above. Still, it is hard to ignore the spreading view that the economy is mired in rougher waters than was envisioned a few months ago. Even the Fed, at its last policy-setting meeting, abandoned its long-standing conviction that transitory forces have been primarily responsible for the economy's underperformance this year. We agree. The U.S. economy is far more heavily dependant on consumer spending than anywhere else in the developed world, and households are firmly in the grips of a deleveraging process that will take at least another year to play out.

To the extent that households are reducing debt and building up savings, they are not spending. That malfunctioning cylinder, which drives 70 percent of the economy's growth engine, is a major headwind that will persist throughout the remainder of the year. What's more, the moribund housing industry is showing no sign of reviving any time soon. Housing starts fell by another 1.5 percent in July to a seasonally adjusted annual rate of 604 thousand units. As can be seen, since the expiration of the homebuyer's tax credit last year, homebuilding activity has gone virtually nowhere, bouncing along a historic bottom month after month. Things will not get much better until the overhang of distressed properties for sale is whittled down significantly, as these homes are being offered at prices that are well below what homebuilders can offer to new-home buyers.

The paradox behind the languishing housing market is that conditions have never been more favorable for home buyers. Mortgage rates have plummeted to an all-time low, with the 30-year fixed rate hitting 4.15 percent this week, echoing the plunge in Treasury yields. Can a mortgage rate with a 3 handle be far behind? Interestingly, it may be reasonable to also ask if the downward trend in bond yields and the pledge by the Fed to hold short-term rates at near zero for another two years may actually be holding back a recovery in home sales. After all, a potent argument for making a purchase soon has, until recently, been to avoid a prospective increase in mortgage rate that might occur at any time. But with the Fed's commitment to rock-bottom rates at least through 2012, that argument looks less compelling. Granted, but the Fed still does not control long-term rates, which is determined by market forces. Should recession fears fade and the economic news come in better than expected in coming months, the bond market would turn on a dime, as it has many times in the past.

On this positive note, the data during the past week did not paint a universal picture of an economy hurtling headlong into a tailspin. Yes, the housing news was disappointing, but this sector is scraping along a bottom, not dragging down the economy as it was in 2008 and 2009. Also, the Philadelphia Fed index of manufacturing activity for July plunged into recession territory, reinforcing the gloomier view of the economy. But the Philly index is regionally based, and may not be reflective of broader conditions. In contrast, the overall industrial production index posted an impressive rise of 0.9 percent in July, scoring its largest monthly gain in seven months. And, yes, a rebound in motor vehicle production played a major role, as expected, reflecting the easing of supply disruptions from the Japanese earthquake and tsunami. But production for June was also revised higher, and the July gain embraced the majority of key industrial sectors. We continue to believe that the economy remains on the recovery track, although it is turning out to be a tougher and longer slog than imagined a few months ago.

JPT081911-1292

Weekly Economic Commentary: Week of August 15

2011-08-15T08:35:00.000-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF AUGUST 15, 2011

As Phil Rizzuto, the famous Yankee broadcaster, used to say: Holy Cow! Except we're not talking about balls flying out of the stadium. During the past week, there have been enough dizzying fluctuations in the stock market to make even a roller coaster addict drool. In every one of the first four trading days, the Dow Jones Industrial average swung by more than 400 points, ending the week 176 points lower than when it started. But the relatively small net weekly change hardly echoes the heart palpitations that investors must have endured during the period.

We are always reluctant to ascribe reasons for big market moves, which can be ignited by any number of isolated or interrelated shocks. This was one of those weeks with a boatload of catalysts, embracing the economy, politics, Federal Reserve policy, the actions of ratings agencies and an escalating sovereign debt crisis. Throw in the high frequency traders and speculators, and all the ingredients for wild gyrations are clearly in evidence. From a chronological lens, however, the downgrade of U.S. Treasury debt by Standard and Poor's last Friday can be viewed as the spark that lit the conflagration. Ironically, the turmoil generated by the action spurred investors to seek safety in the very instrument that was downgraded, namely Treasury securities. At the close of trading on Tuesday, the yield on the benchmark 10-year issue plunged to 2.14 percent, the lowest level at least as far back as the Eisenhower administration in the 1950s. The rate crept back up later in the week, ending at 2.24 percent, which was still well below the 2.57 percent at the end of the previous week.

The action by S&P drew a considerable amount of attention, not only in the markets but by the administration as well. What raised the hackles of many critics was their indignation over the hubris of a ratings agency that had given a triple-A rating to those infamous subprime mortgage securities, which ultimately proved to be no more than junk bonds underpinning the financial crisis that wreaked havoc with the nation. Leaving aside the merits of the downgrade, however, the critics were just as outraged at the apparent $2 trillion blunder committed by S&P in estimating the projected size of the U.S. debt in its analysis. Essentially, the agency used poor judgment in choosing which trajectory of spending to use in its assessment - both of which are generated by the Congressional Budget Office.

Simply put, S&P used an alternative policy baseline produced by the Congressional Budget Office, rather than the current law baseline. The current law baseline for discretionary spending assumes that discretionary spending -- which is subject to annual appropriations -- will grow with the rate of inflation. CBO's alternative policy baseline, produced in January, assumes that discretionary spending will grow at the rate of nominal GDP. The difference is nothing to sneeze at - a whopping $2 trillion as can be seen in the following table that summarizes the two baselines for fiscal years 2012 through 2021.

Admittedly, many budget analysts rely on CBO's alternative policy baselines. The deficit reduction plans produced by the Simpson-Bowles commission and the Rivlin-Domenici-led Bipartisan Policy Center task force relied to a significant degree on CBO's alternative policy baselines. Those alternative baselines are often more realistic than baselines that reflect current law. For instance, CBO produces alternative baselines for revenues that assume the Bush tax cuts won't be allowed to expire, or that Congress will act as it habitually does to prevent the alternative minimum tax (AMT) from having its legislated impact. CBO also forecasts an alternative baseline for Medicare spending that assumes Congress will act to prevent scheduled payment cuts from having their full effect -- another thing Congress has frequently done.

Clearly, CBO's alternative baseline for discretionary spending may have been more realistic than the current law baseline at times in the past. But following the passage last week of the Budget Control Act (BCA), it made more sense to use the lower, current law baseline for discretionary spending. The BCA establishes caps on discretionary spending that have some teeth; if spending is on track to violate those caps, the BCA provides for a "sequester" that will trigger across-the-board spending cuts. In a nutshell, discretionary spending is on track to be less than the old current law baseline (CBO will probably release its updated forecast fairly soon), so S&P should have used that baseline as its starting point. Ironically, S&P conceded the error, but chose to proceed with the downgrade anyway, arguing that using a lower baseline for discretionary spending didn't change the general trajectory for U.S. debt. That's a valid point -- the growth path for U.S. debt is driven primarily by growth in spending on Medicare, Medicaid and Social Security, and not by discretionary spending. Still, S&P should have had all of its analytical ducks in a row before taking such a significant step.

Notwithstanding the controversy surrounding the S&P downgrade, the financial markets, as noted, had plenty of other things to chew over during the past week. Among the headline-grabbing events, the Federal Reserve probably took top honors, pledging at its policy-setting meeting to keep short-term rates at near zero at least through mid-2013. At first, the stock market swooned over that prospect, since it highlighted the Fed's revised assessment that economic conditions remain much more sluggish than envisioned a few months ago. What's more, it admitted that the so-called transitory factors are only partially responsible for the shortfall and the weaker outlook. But the market soon reversed course and spiked higher, as investors liked the notion that rates would remain low for another two years, which provides more of an incentive to take on riskier assets - i.e., stocks - that promise a greater return.

Interestingly, three voting members of the policy-setting committee (FOMC) dissented with the majority, preferring not to make such a time-specific commitment The number of dissenters was the largest in more than 20 years of FOMC meetings. That said, we would not make too much about the voter disagreement. Similar to other recent dissents, the difference lies more in how policy is presented rather than actual differences in what the fundamental policy should be. The dissenters were from the governors of regional banks, including Dallas' Fisher, Minneapolis' Kocherlakota, and Philadelphia's Plosser, who would have preferred to continue to describe "economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period." In other words, the dissenters were not against maintaining an easy policy for an extended period, but would have preferred more of an open-ended time frame. Our take is that the Fed was correct in delivering a stronger communication to the markets of its intent to keep policy accommodative for a long period of time. This gives the policy makers a little more time for the events around the S&P downgrade of US Treasuries to settle down, as well as a chance to more carefully monitor economic conditions as they unfold.

What's more, despite the Fed's two-year pledge, no one expects it to close off all of its options should conditions warrant a change in policy. Although a third round of bond purchases, or QE3, was not proposed - disappointing some - it certainly is an option should the threat of a double-dip recession intensify and inflation recedes further. Indeed, in its summary statement following the meeting, the Fed said: "The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate." We read this as an indication that the Committee is considering all possible options for providing more accommodation, including QE3.Again, whether it will feel the use of any or all of the tools will depend on incoming economic data and market conditions.

Adding to the confusion as to what course the Fed will follow, the markets received a spate of contradictory economic data this week. Sounding a downbeat note, the government released the monthly trade data for June, showing a much larger deficit than expected, with exports falling much more than imports. The $53.1 billion deficit was considerably higher than what the Commerce Department assumed for the month in its second-quarter GDP data, which portends a downward revision from the original 1.3 percent growth rate estimated a few weeks ago. Also pointing to weaker economy, a startling outcome from the Reuters/University of Michigan survey of consumer sentiment for early August. The sentiment index plummeted from 63.7 in July to 54.9 in August, which was the lowest reading since May 1980.

But those weaker signals were countered by two stronger reports during the week that likely carried more weight in the eyes of economists. First, the Labor Department reported that initial claims for unemployment benefits slid below the psychological 400 thousand threshold for the first time in three months, hitting 395 thousand in the week ending August 6. The four-week average of claims, preferred by analysts because it smoothes out weekly fluctuations, also fell for the sixth consecutive week, moving to the lowest level since the third week in April. Any sign that the job market is getting stronger, affirming the positive July employment report released last week, can only be seen as a major boost for the outlook. Second, the retail sales report for July revealed that consumers increased spending by 0.5 percent during the month. That was about as expected, but the June increase was revised up from 0.1 percent to 0.3 percent, leaving an overall stronger impression of consumer behavior. As long as consumption continues to increase, the odds of a double-dip recession do not look particularly strong. So far, so good.

In light of the lackluster job market, weak income growth and low confidence levels, there is understandably a lot of skepticism as to whether the July increase in retail sales can be sustained. Indeed, more than a handful of industry analysts believe that it is the 20 percent of higher net-worth households that are accounting for 100 percent of the spending increase. That may or may not be so, but it should be noted that even families further down the income and wealth ladder are receiving a solid boost to purchasing power from the recent descent in gasoline prices. As the chart below, derived from our buddies at "Gasbuddy.com" shows, even with the rebound in recent days back to about $86 a barrel, the plunge in crude prices over the past three weeks has been far steeper than the drop in retail gasoline prices. Assuming crude stabilizes around current levels, motorists should enjoy some significant further savings at the pump in coming weeks. Whether that translates into higher spending remains to be seen, but the third quarter is starting to look better than was the case a few weeks ago.

JPT081211-1252

J.P. Turner & Company Selected For "34 Up & Coming Firms"

2011-08-11T10:28:00.001-04:00

Atlanta, GA; August 11, 2011— J.P. Turner was named as one of “34 Up & Coming Firms” by Financial Planning Magazine. The announcement was made in Financial Planning’s June 2011 issue.

Tim McAfee, chief executive officer for J.P. Turner, commented on the recognition: "This is quite an honor for us. The fact that Financial Planning Magazine included J.P. Turner in its selection of "34 Up & Coming Firms," signals that our constant efforts towards business excellence are paying off. We are proud to be included in this recognition."

J.P. Turner & Company, LLC (Member SIPC) is an independent broker/dealer headquartered in Atlanta. Advisory and financial planning services are offered through its affiliate, J.P. Turner & Company Capital Management. Founded in 1997 by Bill Mello and Tim McAfee, the company has grown to more than 200 independent branch offices throughout the United States.

J.P. Turner receives annual recognition as one of the top independent broker/dealers in the country by Investment News and Financial Advisor Magazine. The firm was awarded “Top 10 Stock Brokerage Firms in Atlanta” in 2009 and 2010 by the Atlanta Business Chronicle and “Top 10 Companies to Work for in Georgia” in 2010 by Georgia Trend Magazine.

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Weekly Economic Commentary: Week of August 8, 2011

2011-08-08T09:21:00.000-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF AUGUST 8, 2011

Where's the relief rally? Yes, there was a collective sigh of relief when a bitterly divisive legislature mustered up just enough sanity to pull the nation back from the brink of default. Two days before the highly telegraphed August 2 deadline, Congress agreed to a head-scratching debt-ceiling deal that leaves as many questions as answers regarding both the long-term deficit and its impact on the economy. But since the alternative of no deal would have been ruinous, the markets briefly perked up after president Obama put his signature on the agreement. Stock prices actually moved up modestly on Wednesday for the first time in over a week.'

But the relief was as brief as it was shallow. Following the mild uptick, stock prices came crashing down on Thursday, with the broad indexes plunging by more than 5 percent. At the end of the day, more than $1 trillion of equity wealth had evaporated, something that can haunt the recovery's prospects if shareholders decide that now isn't the time to make expensive purchases. Keep in mind that household balance sheets are still in a weakened state following the historic housing collapse and financial panic of 2008. Home prices are still falling, but a powerful stock market rally over the past two years has restored a big chunk of household portfolios that vanished during the market crash in 2008. If the events of the past two weeks portend the onset of another nosedive in stock prices, the positive wealth effect that supported spending over the past two years could also evaporate.

But a more significant consideration is whether the market's steep plunge on Thursday indicates that the sputtering recovery has already run out of gas. Over the past several weeks, a growing army of pundits has been sounding the alarm that a double-dip recession is just around the corner. It's not the first time that this warning has surfaced during the recovery, of course, reflecting the overall subpar performance of the economy since it exited the Great Recession in July of 2009. However, the threat seems to resonate more vividly now for a number of reasons. First and foremost is that government policies, both monetary and fiscal, have just about exhausted the arsenal of growth-boosting levers that can be used to sustain the recovery. The Fed has kept the federal funds rate at near zero since December 2008 and tried two rounds of quantitative easings with questionable success, making a third round that many are calling for a highly debatable prospect. Washington, of course, has been forced to the sidelines, as any attempt to provide more stimulus is being handcuffed by budget hawks.

Second, the economic data released over the past month have not only been disappointing, they have been downright ugly. The list of under-whelming statistics was punctuated by last week's GDP report, which showed that growth almost ground to a halt over the first half of the year. Indeed, the green shades who delve into the meaning of such numbers have added credence to the recession story, noting that a growth slowdown of the extent seen over the past year correlates with a 40 percent chance of an impending recession. If that's turns out to be the case, it would be only the second time in the post World War 11 era that a recession has followed so quickly on the heels of a previous downturn. The shortest previous recovery took place in the early 1980s, when the onset of a recession in July 1981 occurred precisely one year after the six-month 1980 downturn ended.

Following last week's downbeat GDP report, the news just kept on getting worse early this week. First, the Institute for Supply Management (ISM) reported that its indexes of manufacturing and service-based industries slumped noticeably. Both indexes remained above 50, signaling that more industries were expanding than contracting, but the margin of difference had shrunk to near recession territory. The manufacturing index, at 50.9, was the lowest since July 2009, the first month of the recovery. Then came the report that consumers cut spending on goods and services in June for the first time since September 2009. True, the drop was mainly an artifact of falling energy prices, which pushed the overall personal consumption deflator down by 0.2 percent. In real terms, personal consumption slipped only a tad - 0.03 to be exact - but it was the third consecutive month that real spending fell. As the chart shows, that's the first time real consumption has fallen three months in a row during the recovery, another ominous recessionary sign.

So after digesting months of political squabbling investors turned a closer eye on economic data, and clearly did not like what they saw. That jaundiced view together with increased tremors from overseas - bringing Italy and Spain into the spotlight as key trouble spots - ignited the massive sell-off on Thursday as well as heightened speculation over a double-dip recession. Needless to say, anxiety swelled as the mother of all economic data, the monthly jobs report, loomed on Friday. It would be an understatement to say that fears of lousy jobs report were running high on Thursday, extending the aforementioned string of weak data into the third quarter. But as they say, if you lower your expectations enough, you probably won't be disappointed. Sure enough, the employment report for July, released on Friday morning, did not disappoint. Indeed, it even injected a jolt of optimism into what was shaping up to be a demoralized market environment.

Accordingly, it is only appropriate to first look at the positive elements in the jobs report. The best news was that the economy generated more new jobs in July than expected. Nonfarm payrolls increased by 117 thousand, considerably stronger than the expected 85 thousand gain and more than double the 49 thousand average increase in May and June. What's more, the Labor Department revised those two earlier months up as well, adding 56 thousand more jobs than it originally counted. The news gets even better when just the private sector is considered. Private companies added a respectable 154 thousand workers to payrolls, up from 80 thousand in June. The reason for the discrepancy between the total and private jobs picture of course is the drag from government. In July 37 thousand public workers lost their paychecks, with state and local governments lopping off 23 thousand workers. The Labor Department indicated that most of the state and local government layoffs was due to the shutdown in Minnesota. That may be so, but it shouldn't mask an underlying trend that has been underway for more than two years. Since the recovery began in July 2009, state and local governments have purged 543 thousand workers from payrolls.

Leaving aside the bloodletting in the public sector, which shows no signs of letting up, employment gains in the private sector were broadly based, with most sectors expanding payrolls. Even the moribund construction industry added 8 thousand jobs, a sign that the recent strength in apartment building may be putting hard hats back to work. All told, 58.6 percent of private industries expanded payrolls in July, up from a recent low of 55.4 percent in May. Other bright spots: workers received solid raises last month, as a 0.4 percent jump in average hourly earnings was the largest monthly gain since January. Perhaps the most headline-grabbing stat of all, the unemployment rate fell from 9.2 percent from 9.1 percent. That too was a surprise.

Being mostly in the optimistic camp, we are not ones to denigrate good fortune when it comes our way. The July jobs report was a pleasant surprise, but clearly not a cause to jump for joy. Even the positive elements of the report have to be viewed with caution. The 117 thousand net increase in nonfarm payrolls does not keep up with population growth, and certainly does not make a meaningful dent in the 8.7 million jobs lost in 2008 and 2009. Only 1.9 million of those jobs have been recovered since early 2010. And while the July increase was much better than the tepid gains in May and June, it still fell far short of the 215 thousand average monthly gain registered from February through April.

Nor should we get too excited over the 0.1 percent dip in the unemployment rate, bringing it back to the 9.1 percent seen in May. It would be one thing if the rate dropped as a result of a burst of hiring, soaking up the vast pool of unemployed workers. But as we've seen, 117 thousand does not constitute a burst of hiring. Instead, the unemployment rate, which is derived from a separate survey of households instead of companies, declined because people are dropping out of the labor force. In July, the labor force shrank by an unseemly 193 thousand workers, lowering the labor force participation rate to 63.9 percent. This metric, which is the proportion of the adult population that is in the labor force, either working or seeking a job, has now reached the lowest level since the early 1980s. One reason for the July decline: an additional 137 workers dropped out of the labor force because they were too discouraged of finding a job.

Clearly, a fall in the jobless rate due to a shrinking labor force is not a sign of a healthy job market. The plight of the unemployed worker is as dire as ever. Of the 13.9 million unemployed job-seekers, 6.2 million have been out of work for six months or longer. The average duration of unemployment now stands at an all-time high of 40.4 weeks. Millions of others are either working part time but would like full time positions or are otherwise marginally attached to the labor force. Counting these plus the discouraged workers yields an underemployment rate of 16.1 percent. That's down marginally from 16.2 percent in June, but double the average level that prevailed during the 2001 recession.

Simply put, the July employment report, although not great, gave investors more reason to sigh in relief than the debt-ceiling resolution. Another report as dismal as the ones released for May and June would surely have escalated speculation that a double-dip recession was just around the corner. No doubt, some reassuring hints from overseas that the ECB may purchase the sovereign debt of Italy and Spain also brought some peace of mind to investors, helping stocks to steady on Friday. As well, the better than expected jobs report should take some pressure off the Fed when it meets next week. That said, there will certainly be some talk at the meeting about a possible QE3 should the July jobs report turn out to be a fluke. It should be an interesting meeting, and we will have more to say about it next week.

JPT080511-1217

Weekly Economic Commentary: Week of August 1, 2011

2011-08-01T08:38:00.001-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF AUGUST 1, 2011

Just when you thought things couldn't get messier, they do. Amid all of the confusion, angst and hand wringing over the still-stalled (as of Friday afternoon) debt-ceiling debacle on Capitol Hill, the financial markets received more unsettling news on the economy. On Friday morning, the Commerce Department released figures depicting a recovery that is not only struggling mightily; it is climbing out of a far deeper hole than originally thought. The new data show that the economy grew at a much slower rate in the second quarter than expected by economists, but the shortfall for the April - June period only tells part of the dispiriting tale that continues to unfold.

First a rundown of the second-quarter figures, which are bad enough. Real GDP - the broadest measure of the economy's performance - eked out an annual growth rate of 1.3 percent. That was about half-percent below the already-modest increase expected by the consensus of forecasters. What were the biggest drags? Number one, not surprisingly, was the consumer, which accounts for 70 percent of the total. During the spring months they increased consumption outlays by a barely negligible 0.1 percent, the smallest increase since the recovery began two years ago. In light of the monthly data that had already been released on retail sales and the recognized knock-on effects of higher gasoline prices, some pullback was expected. The extent of the setback, however, caught everyone by surprise.

The two other significant drags came from the auto industry and the embattled government sector. As is well known, the horrific earthquake and tsunami in Japan stifled production of Japanese auto parts which left auto makers in the U.S. unable to produce as many cars as planned. The impact of production cutbacks by the industry was palpable, shaving .12 percentage points from GDP during the period. That may not seem like a lot, but motor vehicle output contributed 1.08 percentage points to the economy's growth rate in the first quarter, so that's a swing of almost 1.25 percentage points which looms quite large in the context of a 1.3 percent overall growth rate. Then there is the budget-strapped government sector. Although higher defense spending lifted Federal outlays a tad, state and local governments continue to downsize, slicing .41-percentage point from GDP in the second quarter.

For the most part, all of the feeble growth in the second quarter can be attributed to business capital spending and trade. Capital spending increased by a fairly respectable 5.7 percent annual rate, imparting a modest 0.41 percentage point boost to GDP. Even so, that was a slimmer gain than the 8.7 percent posted in the first quarter and the weakest in two years. Likewise, exports turned in a solid 6 percent growth rate, comfortably exceeding the 1.3 percent increase in imports. The resulting narrowing of the trade deficit contributed more than a half percentage point to the GDP growth rate. However, the combination of exports and capital spending accounts for only 20 percent of GDP, so they cannot be expected to send the recovery into a higher gear without support from other key sectors.

But the real shocker to come out of the GDP report was the downward revision in economic activity over the previous three years, including the first quarter. Prior to revision, the economy was thought to have increased at a 1.9 percent annual rate in the January-March period. That was bad enough, considering that a 3 percent growth rate is considered to be the bare minimum needed to whittle down an intolerably high unemployment rate. But the revised figures show that the recovery downshifted to a near stall-speed during the period, increasing by a puny 0.4 percent. Combined with the 1.3 percent in the second quarter, that means the economy expanded by less than 1 percent over the first half of the year. Such an abysmal growth rate goes a long way towards explaining why such a meager number of jobs has been created this year. Companies have little incentive to add to payrolls when growth, a proxy for demand, continues to languish.

What's more, the statisticians also took a big slice out of economic activity in prior years. While growth was left essentially unchanged for 2010, it was lowered by 0.3 percent in 2008 and by a sizeable 0.9 percent in 2009. As a result, the Great Recession was even greater than originally thought and the uphill climb the recovery has to navigate is considerably steeper. How much steeper? Originally, it was thought the economy had contracted by a formidable 6.8 percent during the worst quarter of the recession. Now, the contraction in the fourth quarter of 2008 stands at an even uglier 8.9 percent. The drop in the following quarter was also revised from 4.9 percent to 6.7 percent. Hence, what had already been the most severe downturn since the 1930s turns out to have been even worse than originally calculated.

That's what makes this lackluster recovery even more disconcerting than is already the case. Keep in mind that recoveries usually bear a strong inverse correlation to the depth of the recession. The harsher the recession, the stronger the snapback. But as we have discussed in previous commentaries, this has not been your garden-variety recession, one that is usually induced either by a mistimed policy mistake or a deliberate attempt to stifle growth in order to curb inflation. Following such recessions, the eventual easing of the credit-strangling monetary policy and lower interest rates would power a strong housing rebound and encourage households to satisfy pent-up demands. Those two drivers would then become powerful catalysts for businesses to invest in new capacity and expand payrolls. In essence, a sequence of self-reinforcing events would be set in motion that, after a burst of activity in the initial recovery stage, would lead to a sustained expansion until all available slack in the economy was used up, bringing a more restrictive anti-inflationary policy back into play.

The current recovery, however, comes on the heels of a recession that was caused by a financial crisis and housing meltdown, not by a growth-retarding monetary policy. It can be argued that the Fed kept its policy too easy for too long, which facilitated the credit and housing bubbles that ultimately collapsed, ushering in the financial crisis and Great Recession. But that's an argument for another day. The point is that such recessions have historically been followed by sluggish recoveries, which are characterized by below-par growth for a longer period of time. In contrast to normal recoveries, the healing process requires an extended period of deleveraging and the working off of the speculative excesses built up during the bubble years that prevent a typical rebound in housing demand and consumer spending. Simply put, the usual catalysts that propel a burst of rapid growth early in the recovery have been conspicuously absent from the current cycle.

Indeed, prior to the government's latest revisions, it was thought that the economy might actually have climbed out of the recovery stage and moved into the expansion phase of the upturn. That's because the earlier figures showed that after two years of even sub-par growth, the nation's output had finally exceeded the peak level reached just before the recession set in. However, that's no longer the case. With the downward revisions noted earlier, real GDP has not yet reached its pre-recession level. At $13,270 billion in the second quarter, total output of goods and services falls $56 billion short of the level that prevailed in the fourth quarter of 2007, the final quarter of the last expansion. If the economy registers another 1.3 percent rate of increase in the third quarter of this year, it would still not reach its pre-recession peak. In no other post-war upturn has it taken this long to recover output lost during the recession.

The good news is that while economies have historically taken longer to recover from financial crises, they do not peter out any sooner than do typical recoveries. In other words, the wounds from a financial crisis may take longer to heal, but the healing process continues until it is completed. Many skeptics, however, claim that "this time is different", citing the twenty five million Americans who still cannot find full time jobs, stagnant wages and a moribund housing industry that remains mired in a foreclosure crisis with no end in sight. Their contention is that the economy has little or no firepower to sustain the recovery, particularly since Washington is unable or unwilling to provide more stimulus for growth. At the very least, an economy that continues to struggle along at a sub 1 percent pace remains highly vulnerable to any external shock, which could easily send it off the recovery track.

That's a hard argument to refute, but we still adhere to the consensus view that the recovery will persist and pick up some momentum as the second half of the year unfolds. For one, the disruption of car production caused by the Japanese disaster is no longer dragging down growth. Odds are, the revved up auto assembly schedule already in place will give a solid boost to GDP in the third quarter, perhaps similar to the 1 percent boost it provided in the first quarter of this year. Also, gasoline prices have receded from the spring peak, which will put some extra cash in household pockets for discretionary spending. Prices have recently started to edge higher again, but it's doubtful that they will return to their earlier peaks unless geopolitical tensions escalate among oil-producing nations. As discussed last week, households are still deleveraging, but the process is well into its late stage and is becoming less of a deterrent to spending. Indeed, household balance sheets should be back to a fairly healthy state by the fall or winter months.

Finally, the housing industry is hardly out of the woods. But like the consumer deleveraging process, it is becoming less of a drag on growth. Indeed, residential outlays even posted a small rise in the second quarter, suggesting that construction spending is going through a bottoming out process. And, assuming the uncertainty over fiscal policy does not put the kibosh on business spending, capital outlays should continue to provide support to the recovery in coming quarters. True, new orders for nondefense capital goods excluding aircraft - a precursor of future capital spending - came in weaker than expected in June, falling by 0.4 percent. But that only partially offset the more robust 1.7 percent gain turned in the previous month. More tellingly, shipments of nondefense capital goods - a proxy for actual capital spending - rose sharply in June and stood a robust 8.5 percent above the second quarter average. Hence, capex has some solid forward moment heading into the third quarter, another reason to believe that growth will pick up somewhat. Make no mistake; there are a prolific number of downside risks to the economy going forward and the ongoing confidence-shattering debacle in Washington over the debt ceiling only adds to the headwinds. Hopefully, a sensible resolution will be cobbled together over the next several days, lifting at least one obstacle in the recovery's path.

JPT072911-1173

Weekly Economic Commentary: Week of July 25, 2011

2011-07-25T08:25:00.000-04:00

WEEKLY ECONOMIC COMMENTARY

Stone & McCarthy Research Associates

WEEK OF JULY 25, 2011

We can only surmise that the heat wave blanketing the U.S. is causing politicians in Washington to hallucinate. As of Friday morning, Republicans and Democrats continued to play chicken with each other over the debt-ceiling issue, seemingly oblivious to (or willing to risk) the stakes involved if a resolution is not reached over the next ten days or so. Speaking of heat, the past week has been one for the record books; the National Weather Services reported that forty states experienced temperatures in the 90s and 17 of them suffered through stifling heat of 100-degrees or more. What gets us worried is that the thermometer is expected to reach 103 degrees in Washington on Friday. Let's hope the A/C is working full blast on Capitol Hill so that the American public can at least hope for a cool breeze of logical clarity.

Being optimists, we do think that Congress and the Administration will reach some kind of agreement that allows for an increase in the debt ceiling in early August. We don't know what that agreement will look like -- it could be the new plan coming from the Gang of Two (President Obama and House Speaker Boehner), the McConnell-Reid kick-the-can plan, or something else. As the week drew to a close, the press was full of news about deals and denials of deals between President Obama and House Speaker Boehner on a deficit reduction plan. Our take after reading several articles from sources we trust is that Obama and Boehner have something in the works, if not a deal. Too many news organizations have too much information -- it's hard to believe that wasn't intentional. However, neither side wants to confirm an agreement officially or reveal too many details. To do so would invite opposition and make any progress that much harder.

As the saying goes, it ain't over 'til it's over, and until it's over, we think we'll be hearing and seeing lots of conflicting reports. Increasingly, we think something will be done to increase the debt ceiling by August 2 or shortly thereafter. Still, a deficit reduction deal or debt limit increase is far from guaranteed, so as we get down to the wire we thought we would look more closely at the government's cash position in early August and the likelihood that the Treasury can use some time-honored smoke and mirror measures to avoid default. By our calculations, the Treasury can buy some time, but only for about a week or so beyond the stated August 2 deadline. The table summarizes our cash flow projections for the first two weeks of the month, assuming that there has been no increase in the debt ceiling. The projections assume that Treasury will be able to at least roll over maturing debt on August 4 and 11, but the 15th is questionable. As the table shows, the Treasury is expected to have a negative cash balance of $15.5 billion, which implies that the government wouldn't have the resources to pay $30.6 billion in interest on that day.

However, the period between August 2 and 15th would be complicated by another issue if the debt ceiling isn't raised. The Treasury will need to roll over $200 billion in maturing issues during that period and in a recent letter to Senator Jim DeMint, Treasury Secretary Geithner said that some market participants have indicated that they would be "disinclined" to participate in Treasury auctions if we get into August without a debt limit hike. We wonder to what extent Treasury -- and perhaps the Fed -- would pressure the 20 primary dealers to participate in Treasury auctions to ensure that the government can roll over its maturing debt. One of the responsibilities of being a primary dealer is to participate in Treasury auctions. According to FAQs on the New York Fed's website, "Primary dealers are also required to participate meaningfully in all auctions of U.S. government debt, including an underwriting commitment..." It's not clear how that commitment would be enforced in the event that one or more of the rating agencies downgraded the debt of the U.S. government.

Again, our base case scenario is that the legislators get their act together and increase the debt ceiling before the financial markets - which have so far been relatively calm considering the potential consequences of default - throw in the towel and become the vigilantes from hell. One encouraging omen is that an even more diverse group of politicians in the European Union agreed to a bailout plan for Greece on Thursday that, while drawing a goodly amount of criticism, has calmed the global markets for the time being. We also wonder how much of a toll the debt-ceiling debacle as well as the European debt crisis has already taken on the economy. There's a time-honored adage that financial markets abhor uncertainty, but that sentiment applies to businesses as well. All the heated talk of a possible Armageddon if the U.S. government defaults on its debt could well have prodded companies to put major decisions on hold, including whether or not to expand payrolls. It may or may not be a coincidence that job growth nearly ground to a halt in May and June, just as the debt issues heated up.

To the extent that uncertainty impeded growth in the second quarter, an agreement on the debt ceiling would transform a headwind into a tailwind and perhaps give a welcomed boost to the economy in coming months. But the majority of forecasters have downgraded expectations for the second half of the year, and their perception is not likely to change anytime soon. One reason: the hope that consumer spending would pick up strength in a meaningful way has faded as job growth wilted and gasoline prices took a bit bite out of household incomes during the spring. Fuel prices have fallen from their early-May peaks, but they recently started to edge up again, reducing the amount of savings that consumers could have used to spend on other goods and services.

Indeed, from our lens, consumers are still behaving more like savers than spenders. The spiral in gasoline prices from last August through May of this year took a major chunk out of household savings, which needs to be replenished. Meanwhile, the huge debt buildup during the easy-credit, housing bubble days that spurred households to spend beyond their means is still being unwound. As a result, the deleveraging process is also cutting into consumer spending, as paying down debt is just another vehicle to increase savings. However, there is some positive news on the deleveraging front. First, households have whittled down their debt to income ratios, from an historic high of 133 percent in 2007 to 119 percent at the end of the first quarter.

To be sure, that's still high by historical yardsticks - the average for the 1980 - 2005 period stood at 88 percent. However, the burden of servicing that debt has lightened significantly, thanks to rock-bottom interest rates and widespread refinancings in recent years. In the first quarter, for example, the share of incomes devoted to interest and principal payments on outstanding debt slid to 11.5 percent, which is a far cry from the 14 percent high set in 2007 and the lowest since 1995. Simply put, the deleveraging process is well into its advanced stage and its restraining impact on spending should wane over the second half of the year. Indeed, consumers are showing more of a willingness to borrow again, as credit-card debt increased in May for the first time this year and only the second time since August 2008.

Assuming, as we do, that the economy will generate more jobs than the tepid 22 thousand monthly average created in May and June, consumers should spend at a modestly stronger pace in coming months than they have over the first half of the year. But a robust rebound that would kick-start the recovery into a sustained higher gear is not in the cards. Keep in mind that the pent-up demand that usually gives a major boost to recoveries is less of a factor this time, if only because households stocked up on durable and other discretionary goods during the bubble years prior to the Great Recession. Hence, while the drop-off in consumer spending was huge during the downturn, so too was the degree of overspending during the expansion. Simply put, there is less unsatisfied demand to fill.

For another, the rebound in housing-related expenditures - for appliances, furniture, carpeting, moving expenses and such - that typically accompany a cyclical upturn in housing activity is conspicuously absent during this recovery. The reason is obvious: the housing recovery has been a no-show since the economy exited the recession two years ago. Indeed, housing has not only failed to support the recovery, it has been sucking the air out of the upturn. Forget the surprising 14.6 percent increase in housing starts in June reported this week. Most of the gain was in multi-family starts, which surged by 30.4 percent, as rising rents and shrinking vacancy rates are spurring a big jump in apartment construction. But the strength in demand for rental units is the flip side of the weakness in demand for home purchases. Essentially, households are choosing to rent rather than buy a home, a trend that will continue until house prices drop enough to lure homebuyers back into the market.

True, construction of single-family homes also increased in June, but the gains were posted mainly in the South and Midwest where tornadoes inflected severe damage during the spring. Odds are, the increases in those regions reflect rebuilding efforts. Still, building permits for single-family units ticked up for the fourth consecutive month in June, suggesting that homebuilding activity may finally have bottomed out. Given the record low level of unsold newly built housing units on the market, that's not too surprising, as builders do not want to be caught short if home sales come in stronger than expected in coming months. That said, the likelihood of an abrupt revival in new home sales is not very high, given the strong competition from the existing home market that continues to draw potential customers away from builders.

In two weeks, the jobs report for July will provide us with the first indication of how the second half of the year is starting out. We would be surprised if it showed a big gain in job creation, and disappointed if it comes in close to the weak May and June readings. In the interim, however, the markets will be fixated more on Washington than on the statistical data mills. While Wall Street and Main Street are not connected by the hip, they will both be deeply effected if political gamesmanship continues to override rational thinking.