The US economy: A sigh of relief

Last week's US indicators provided welcome relief from the prior week's disappointing manufacturing and housing data. Last week I warned that it would be the consumer that would have to drive the economy forward over the next couple of months. Having the consumer in the driver's seat isn't necessarily a bad thing. It is just a lot harder to predict than the manufacturing sector, which has longer lead times and a plethora of reliable early indicators.

Consumers, on the other hand, are more fickle with their spending habits, making them more challenging to predict from week to week. Last week's consumer-related news was outstanding. Incomes and investment portfolios have shown enhanced gusto recently. Those factors, combined with continuing declines in the number of layoffs, are stoking the embers for improved consumer spending, and a better-than-anticipated holiday season.

Labour market data
The most exciting news last week for the consumer was a dramatic decline in the number of new initial unemployment claims, as well as the number of continuing claims. Initial claims for the week fell to 466,000 (496,500 on a four-week moving average basis). One has to go back to autumn 2008 to find a lower number. I should warn that the seasonal adjustment factor this week was quite large, so it wouldn't surprise me to see the one-week number bounce back a little next week. However, I expect initial claims to remain below the 500,000 level.

Even without last week's great data, initial claims have shrunk at the same pace or faster than each of the last five economic recoveries, according to Morningstar insurance analyst Bill Bergman. According to the Wall Street Journal, initial claims of between 450,000 and 500,000 are consistent with job monthly losses of 40,000 or so.

The wide discrepancy between claims and jobs is due to new hires. I don't think the number will be quite that good for November, as I anticipate job losses of 80,000 to 160,000 or so, with a shot at growth in December or January.

Consumer savings and spending
Last week also brought news that both consumer incomes and consumer spending were up for the month of October. Real disposable income, one of the better predictors of consumer spending, was up 0.2% in October compared with a 0.1% increase in September. On a year-over-year basis, real disposable income has been up by more than 2% each of the last three months. That is the underlying reason I believe that holiday sales will beat the consensus forecast for flat revenues. Consumers showed some willingness to spend some of that income, too, as real consumption expenditures for October increased 0.4%, faster than the pace of income growth.

A combination of faster growth in spending and good, but more modest, income growth caused the overall savings rate to decline to 4.4% from 4.6% the previous month. That savings rate is up sharply from its low of 0.8% in early 2008. So, with incomes up, a little more savings in the bank versus last year, and sharply higher financial markets, the conditions necessary to generate healthier consumer spending seem to be in place. The question is, will the consumer have the confidence to spend some of that money?

Retail sector insights
At the high end of the market, the news is looking better. Last week, a number of high- to mid-level retailers, including Tiffany and J.Crew, reported better than expected results (as did Saks and Nordstrom's earlier in the month). In addition, several of these retailers raised their near-term guidance. More broadly, chain store sales have been up on a sequential basis for seven of the last nine weeks, including the results reported this week.

Corporate benefits
Improvements in 401(k) [US company pension] matches, a thaw in some salary freezes, and selective hiring may aid consumer confidence as well. Watson Wyatt, the benefits consulting firm, recently indicated that firms planning to reinstate their 401(k) matches had moved up from 5% in June to 25% in August to 35% in October. The unfreezing of salaries showed even more dramatic results as the number of firms planning to lift freezes moved from 17% to 54%. I should caution that this data is skewed toward larger firms, but the results are nevertheless encouraging. You can read more about the Watson Wyatt data here.

GDP & manufacturing
The news last week wasn't all wine and roses. As I anticipated, GDP for the September quarter was revised downward to 2.8% from 3.5% due to weaker retail sales for September, less construction and more imports. The market took the number in stride, much to my surprise. Durable goods orders were also soft, declining 0.6% in October. Again, this was not a real surprise. Anything that relates to manufacturing is going to have to start to level out unless consumer demand improves. For a period of time, production was so far below even depressed sales levels that manufacturing statistics could do nothing but go up. Those days are over. Though, as sales levels improve, manufacturing still has a lot more upside.

Housing data
News on the real estate front last week was far better than I had anticipated. Existing home sales jumped by over 10%. Then, new home sales jumped 6.2%, to 430,000 units. Because buyers were unsure if the housing credit would be extended, this strong statistic did not have the favourable tailwind of the past several months, suggesting that there is hope for the market beyond all the stimulus. Meanwhile, new home inventories fell to 293,000 units, the lowest level in four decades.

Yes, I said decades. With starts down dramatically in the previous week and sales up, the potential for more construction early next year is high. The Case Shiller Housing Price Index continued its improvement during September, though the monthly gains were smaller than during the summer months. Similar data from the Federal Housing Finance Agency also reflected a small gain for September after a small decline in August. Year-over-year, the decline in housing prices was just 3.8%, well off its worst levels. Going into the winter months, it may be hard to see much improvement in the price indexes over the next several months. As long prices don't renew their rapid decline, I am not particularly worried about the effect on the economy. Short-term pricing will be a tug of war between higher foreclosure rates and greatly diminished inventories.

Jobs numbers key next week; Ignore the manufacturing data
As I alluded to earlier, the jobs report is due this coming Friday. Job losses of between 80,000 and 160,000 would not surprise me, and would be a meaningful improvement from last month's 191,000 jobs lost. Just as importantly the average work week, hourly wages and temporary help data will all be released, and I expect improvement on all fronts. Auto sales are also due, and they should be relatively flat, at 10.5 million units (seasonally adjusted annual rate). This number is well off its 9.1 million low, but still below the more typical 14-18 million level.

The ISM purchasing managers' reports are also expected this week. I would suspect these numbers will be a little weaker than they were during prior months, especially on the new orders front. At this point in the cycle, these numbers are a little less relevant than they were earlier in the recovery. It will be interesting to see how the market will react to these numbers if they do prove to be weaker than expectations.