US economy starting to hum again

While last week's economic indicators were positive, I was most impressed with corporate reports in two sectors: technology and transportation. On the technology side, software giant Oracle reported new-license growth after four consecutive quarters of decline. Though Oracle has been a little late to the improvement party, an uptick in this key sector is an important indicator of corporate confidence.

Transportation maven FedEx reported much better than expected volumes during its busiest day of the year. The transportation sector has been a bit of a laggard this year, and I was very glad to see volume gain some headway. If we aren't shipping things, then we aren't building things, either.

Speaking of production, the best economic data last week was a strong industrial production number, which is now up for the fifth consecutive month. Headline inflation numbers, especially on the producer side, looked a little scary. However, further investigation shows that a short-term spike in energy prices was the main culprit.

Holiday guessing games
Friday's Wall Street Journal article indicated that in the game of chicken between retailers and consumers, neither side has blinked yet. Discounts remained controlled, but consumers are lagging in their holiday spending plans, according to the article. Our retailing team noted that the previous week's sales reports were looking a little better than last year's, but it is still too early to tell if this holiday season will be any merrier for the economy.

All of this is a fun guessing game, but total consumption includes services, housing, and autos (and not just chain store sales), and this is a key driver of GDP and employment. That said, my personal best guess is for holiday sales to be up about 2% from a year ago. However, given that these numbers will be regularly revised through March, I am not holding my breath.

Industrial production report makes it five in a row
Since the industrial production index bottomed last June, production has notched gains each and every month, with November showing relatively robust growth of 0.8%. Our industrials and homebuilding analyst Eric Landry notes that five months into the recovery, production is up 3.7%, which is considerably better than the start of the recoveries of the 1990s and 2000s, but less than the 4%-5% growth in the wake of the recessions of the 1970s and 1980s.

Given the depth of the collapse earlier this year, Eric believes we still have considerable room for improvement in the months ahead. I am still at least partially optimistic because production is still notably lower than year-ago levels, while consumption levels are getting very close to what they were at this time last year, as inventories have been drained to make up the gap.

Energy prices inflate both consumer and producer price indices
The consumer price index jumped sharply, to 0.4%, driven almost entirely by a 6.4% increase in gasoline prices when comparing November with October. Excluding food and energy, there was no growth in the CPI. Falling rents basically offset gains in health-care, airline tickets, and motor vehicles.

When comparing the year-over-year November period, prices were up 1.8% in total and up 1.7%, excluding food and energy. This is the first time since February that the year-over-year rate has been a positive number. With energy prices lapping easy comparables, and the subsequent bounce, I would suspect that headline year-over-year inflation could top 3% in the months ahead.

Separately I think the December 2009 to December 2010 inflation rate will also be in the 3% range, which is well ahead of consensus estimates of around 2%. Faster than expected GDP growth of 3.5%-4.0% growth, as well as pockets of goods with tighter supply/demand issues, could be the drivers of a higher than anticipated inflation rate.

The producer price index, often a precursor to CPI, spiked 1.1% during November, which was more than I had anticipated. Like the CPI index, energy prices were the culprit. Without food and energy, the index was still up 0.5%, which is a little higher than I would like to see. The silver lining on the PPI is that prices for the prior month were down a surprising 0.6%, so the unexpected jump this month and the unexpected decline last month just about offset each other.

Housing starts back in growth mode, much, much more room to go
After a noticeable setback in housing starts last month, total housing starts jumped 8.9% during November. The less volatile single family figure was up a more modest 2.1%. However, starts are embarrassingly low, at 574,000 on a seasonally adjusted annual rate basis. This compares to a natural demand rate of 1.5 million units, and a peak of over 2 million units. When all is said and done, full-year starts for 2009 will be about 550,000 units, marking the fourth consecutive annual decline in housing starts, according to our housing analyst Eric Landry. From these levels, there isn't anywhere to go but up. Starts of 700,000 to 850,000 for 2010 aren't out of the question. Housing production at these levels would be a nice positive for both GDP growth and employment growth.

Initial unemployment claims meander up, but don't panic
Initial unemployment claims crept back up to 480,000 from 474,000, their second weekly increase. The less volatile four-week moving average continued its downward trend. Claims have held in there better than I would have expected over the last month. I was afraid that a lot of corporations with year-end employment targets that were hoping for normal employee attrition would be forced to bite the bullet and make forced layoffs in December. Therefore, I wouldn't be too concerned if we had a couple of bad weeks in December, and I would look for better results in early 2010. With retail hiring being somewhat light this holiday, layoffs in 2010 should also be more muted.

Personal income/spending data should lead the way this week
For a holiday week, this week is packed with a lot of data. The most important will be the personal income report, which is due on Wednesday. That report contains a wealth of data on consumer incomes, expenditures, and the savings rate for the month of November.

Because the consumer represents more than 70% of the economy (GDP), these numbers are exceptionally important. Large swings in the relatively small investment portion of GDP have been the key drivers of economic improvement in recent months, and now the consumer needs to kick it into gear. I expect the news here to be good.

Hours worked for November were up, as were wages. Employment was basically flat, which should drive the wage portion of personal income higher. An increase of 0.5% or more for personal income looks plausible. Income is the fuel that drives consumption. I suspect that consumption may even look a tad better than incomes, at 0.6% or better. I base my optimism on a very strong retail sales report and improving auto sales.

With rising incomes and more robust spending, I suspect the savings rate is in for a decline. This week, we also get existing home sales and new home sales for November. I suspect existing home sales to be relatively flat. Those numbers had been inflated a bit, as "last-minute Charleys" raced to spend their first time homebuyers' credit (to the detriment of new home sales, which take longer to close). The inverse of this effect is, I expect, new home sales to show a bounce in November from poor October results, when they are reported on Wednesday.

Watch for the durable goods order report on Thursday. This tends to be more of a coincident to lagging indicator. After a negative showing in October, I believe 0.5% growth in November is possible. However, this is a volatile series that is hard to interpret because of large transportation orders. The final GDP revision should be relatively unchanged from the prior government estimate at 2.8% for the September quarter. Although I will get a much better feel for the December quarter after next week's data, my early guess is that GDP growth could get close to 4%. However, we'll have to wait until the end of January for that number. If it's as good as or better than I think it will be, then maybe the best holiday presents really do come late.