EconomPics of the Week (4/30/10)

These posts are from the last two weeks (no 'EconomPics of the Week' last week as there were only four posts).

Economic Data
GDP Growth Slows in Q1: Back to Reliance on the Consumer
How Far Had We Fallen? A LOT...
Year over Year GDP Breakdown
College Enrollment Rate at New High
Consumer Confidence Increases in April
Corporate Earnings: Mixed, but Broadly Upgraded....
Food and Energy Drive PPI Higher
Leading Indicators... Growing Strength
Continued Widespread Deflation in Japan

Asset Classes / Returns
Fixed Income: One Long Round Trip Edition
Year over Year Housing Prices Up for the First Time Since '06
Is the S&P 500 at Fair Value?
More on the S&P 500 Relative Value
You Call that a "V"?
A Greek Tragedy
The Greek Blow Out
The One Day Unwind?
Just a One Day Unwind...
More on the Housing Overbuild
Consumer Confidence Increases in April
Mass Layoffs...
Texas Manufacturing: Recovery Gaining Traction
Federal Reserve "Printing" Money

And your video of the week... Vampire Weekend with A-Punk

How Far Had We Fallen? A LOT...

I "borrowed" the concept of the chart below from Calculated Risk, which showed the GDP declines from the prior peak for post WWII recessions in REAL terms (this downturn doesn't actually look too different).

The real level is of course more relevant than nominal level in most cases. HOWEVER, nominal matters a lot to country that is very indebted as debt is nominal (i.e. you get to pay it back in nominal, not real terms, which is why the thought of "inflating" debt away is so attractive to some).

As can be seen above, the decline in nominal was really unparalleled over the past 50 years and only now are we back to previous peaks (yet I still calculate us ~$1 trillion below trend). Yet another reason why, on the margin, we are at risk of suffocating under our indebtedness.

Source: BEA

Year over Year GDP Breakdown

Same type of chart as this morning, but with year over year figures (rather than quarter over quarter annualized) and going back to Q1 '09 (every other quarter).



Source: BEA

GDP Growth Slows in Q1: Back to Reliance on the Consumer

Marketwatch details:

U.S. consumer spending rose at the fastest rate in three years in the first quarter of 2010, powering the economy to a 3.2% growth rate, the Commerce Department estimated Friday.

The 3.2% increase in real seasonally adjusted gross domestic product was exactly as expected by economists surveyed by MarketWatch. See our complete economic calendar and consensus forecast.

GDP is up 2.5% in the past year, following the worst downturn in generations. GDP rose at a 5.6% pace in the fourth quarter, primarily because of inventory reductions.

In the first quarter, by contrast, private domestic demand was the main engine of growth. Consumer spending rose at a 3.6% annual rate, while business investments in equipment and software increased at 13.4% pace.

So we're back to relying on an extended consumer for economic growth... nothing changes.

Source: BEA

Continued Widespread Deflation in Japan

Bloomberg details:

Japan’s consumer prices fell for a 13th month in March, indicating the economy remains hampered by deflation even as the export-led recovery starts to spread.

Prices excluding fresh food slid 1.2 percent from a year earlier, after dropping 1.2 percent in February, the statistics bureau said today in Tokyo. The result matched the median estimate of 28 economists surveyed by Bloomberg News.

Source: Stat.GO

College Enrollment Rate at New High

Economix details:

More than 70 percent of the members of the high school graduating class of 2009 were enrolled in college last October. That is the highest portion on record, which goes back to 1959, according to a new Labor Department report.

The below chart provides details of how likely these high school graduates (aged 16-24) were to enter the work force, as well as the success they have had getting actual work.



Not a surprise that those not enrolled in school are more likely to enter the workforce than those enrolled full time, but surprising to me is the lack of relative success someone not enrolled in school has getting a job. My guess is they are looking for the more difficult to get full-time jobs, but that difficulty is likely to explain why the college enrollment rate among high school graduates has continued to increase.

While a tough job market has been a negative over the short-run, an educated work force will hopefully pay dividends over the longer term.

Source: BLS

Just a One Day Unwind...

Yesterday, I asked if the sell-off was just a one day unwind? For the time being, it indeed looks like any dips may still be buying opportunities.



Source: Yahoo

You Call that a "V"?

This... is a V!

Bloomberg with the details (hat tip to Rolfe Winkler).

Junk bonds are trading within a half cent of face value for the first time since June 2007 in a sign investors are convinced the economic recovery and profit growth will keep the neediest borrowers from defaulting.

High-yield bonds rose to 99.67 cents on the dollar, up from a low of 54.78 cents in December 2008, according to Bank of America Merrill Lynch index data (the chart below is the BarCap High Yield index). The debt last reached par on June 11, 2007, just before credit markets began to seize up as losses on subprime mortgages spread.

JPMorgan Chase & Co. and Morgan Stanley Investment Management are recommending investors buy the debt, even after it returned 86 percent since the market bottomed in 2008. Rising profits are making it easier for companies to meet payments, leading Moody’s Investors Service to raise its ratings on 143 junk bonds this year and downgrade 105, data compiled by Bloomberg show. Last year it upgraded 229 and lowered 902.

Source: BarCap

More on the S&P 500 Relative Value

Earlier this week, EconomPic detailed the relationship between the S&P 500 and nominal GDP and asked "Is the S&P 500 at Fair Value?"

Below is additional detail of those results by decade. Pretty interesting to start in the 1920's (the only data point is 1929) and work through the decades. Definitely shows how we got to the point where we were so extended at the earlier part of last decade.



Source: BEA / Irrational Exuberance

A Greek Tragedy

Money CNN details:

The yield on Greek bonds soared to record levels again, a day after Standard & Poor's slashed its debt rating on the country to junk and amid reports that the IMF is considering more loans to the beleaguered country.

The yield on 10-year Greek bonds surged to 11.24% early Wednesday from 9.68% on Tuesday. The yield is the highest for the 10-year since the introduction of the euro in 2002.

The jump in the yield on the Greek bond has led to an enormous spread, of 8.22 percentage points, compared with German bond yields. The yield on the German 10-year bond, considered the European benchmark, slipped to 3.02% early Wednesday.

Source: BarCap

Corporate Earnings: Mixed, but Broadly Upgraded...

In this week's edition of EconomPic Q&A, a new reader asked:

I'm looking for a report on sector earnings. I want to see what percentage of companies have beat/missed earnings in each sector. Any ideas??

Standard & Poor's has a ton of information on their site, including detailed breakout of all sector components of the S&P 500's earnings estimates. Below is not exactly the answer to the question (percent beat / missed, which is broadly ~75-80% "beats"), but rather how much estimates have changed since earnings season began a few weeks back.



Source: S&P

The One Day Unwind?

Or the the start of something bigger?

Performance during today's risk-asset sell-off was rather interesting. Take a look at the order of magnitude of the downturn across asset classes, as well as the sole survivors?

Specifically, take note of the strength in gold in a day when there was a dramatic flight to Treasuries.

Source: Finance

Consumer Confidence Increases in April

Bloomberg reports:

Confidence among U.S. consumers increased in April to the highest level since September 2008 as Americans became more upbeat about the labor market.

The Conference Board’s confidence index rose more than forecast, to 57.9 from 52.3 in March, according to the New York- based private research group. The median forecast of economists surveyed by Bloomberg News projected a rise to 53.5. A measure of expectations was the highest since 2007.

Pessimism is starting to abate after employers added workers to payrolls in three of the last five months. More job growth will be needed to spark bigger gains in confidence, incomes and spending, which accounts for about 70 percent of the economy.

“Consumers are feeling better about the labor market,” said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts, who forecast the index to rise to 57. “If they are to spend more, they need to have jobs.”

Source: Conference Board

Year over Year Housing Prices Up for the First Time Since 2006, But Momentum Weak

The Washington Post details:

Home prices in February posted their first annual increase in more than three years, though it's too early to say the housing market is recovering.

Despite the 0.6 percent increase on a non-seasonally adjusted basis, 11 of the 20 cities in the Standard & Poor's/Case-Shiller home price index showed declines.

The last time prices rose on a year-over-year basis was December 2006. But economists polled by Thomson Reuters had predicted prices to rise 1.2 percent in February.

Home prices are up more than 3 percent from the bottom in May 2009, but still are 30 percent below the May 2006 peak.

On a month to month basis, the Case-Shiller Home Price Index was relatively unchanged on a seasonally adjusted basis (the Composite 20 dipped slightly, the Composite 10 jumped slightly). Both were below estimates.

What is striking is where the month-to-month increases were concentrated... almost entirely in the west.



And the longer view shows the relative strength (i.e. weakness) of the rebound as compared to the fall.

Source: S&P

Mass Layoffs...

BLS reports:

The Good...

The number of mass layoff events in March increased by 58 from the prior month, while the number of associated initial claims decreased by 4,854. The number of events has decreased in 5 of the last 7 months, and the number of initial claims has decreased in 6 of the last 7 months. In March, 356 mass layoff events were reported in the manufacturing sector, seasonally adjusted, resulting in 39,290 initial claims. Both figures registered their lowest levels since August 2007.

The Bad...

During the 28 months from December 2007 through March 2010, the total number of mass layoff events (seasonally adjusted) was 56,937, and the associated number of initial claims was 5,731,683. (December 2007 was the start of a recession as designated by the National Bureau of Economic Research.)

So the trend is moving down, which is clearly good news. But after a whopping 5.7 million mass layoffs over the past year and a half, it is amazing to me that we are still above the median level of mass layoffs of the last 15 years (i.e. at what point have businesses already cut off all the "low hanging fruit").

Texas Manufacturing: Recovery Gaining Traction

RP details:

Texas factory activity increased for the sixth month in a row in April, according to business executives responding to the Texas Manufacturing Outlook Survey. Results of the survey were released April 26 by the Federal Reserve Bank of Dallas. The production index, a key indicator of state manufacturing conditions, climbed further into positive territory as more producers reported increased activity.

Source: Dallas Fed

Is the S&P 500 at Fair Value?

The first chart shows the relative value of the S&P 500 as compared to nominal GDP (to be more specific... the S&P 500 index / nominal GDP in billions $$) since 1929.



And the importance of such a measure.... the ten year forward annualized change in the S&P 500 index vs. the starting S&P 500 to nominal GDP ratio since 1929.



The above has a remarkable 0.73 r-square.

Where are we now? Well, assuming the economy grew at the 3.2% annualized rate that has been forecasted for Q1, at current levels the S&P 500 is ~8.4% of nominal GDP (in billions $$).

Or just about at the 80 year average.

Source: BEA

The Greek Blow Out

Bloomberg details:

The yield premium investors demand to hold the nation’s 10- year bonds rather than German bunds climbed to more than 600 basis points after the Financial Times cited German Finance Minister Wolfgang Schaeuble as saying Greece must firm up plans for deficit reductions in 2011 and 2012, and not just for this year, to qualify for aid. Citigroup Inc. said a reorganization of the debt or need for extra support looks “unavoidable.”

The 10-year Greek bond yield jumped 78 basis points to 9.58 percent as of 11:30 a.m. in London. The 6.25 percent security due in June 2020 slid 4.34, or 43.40 euros per 1,000-euro ($1,333) face amount, to 78.86. The two-year yield jumped 300 basis points to 13.96 percent, after soaring the most on record to 14.66 percent.

Source: BarCap

Fixed Income: One Long Round Trip Edition

A lot has happened since the summer of 2007, about the time when the word "subprime" entered mainstream culture (fun fact, it was the American Dialect Society's word of the year for 2007).

But, for all that's happened (bank failures, recession, credit freeze, unemployment spike, inflation and deflation concerns, quantitative easing, European sovereign risk, housing collapse, oil spike / freefall, etc...) the Treasury, Investment Grade Corporate, High Yield Corporate, and TIPS fixed income sectors (as measured by their BarCap benchmarks) have almost identical cumulative performance over that time frame.



Source: BarCap

Food and Energy Drive PPI Higher

Marketwatch details:

Higher prices for vegetables helped drive U.S. wholesale prices higher by a seasonally adjusted 0.7% in March, reversing a drop in February, the Labor Department estimated Thursday. The producer price index has risen by 6% in the past year, led by a 23% rise in energy prices, the government agency said.

Excluding often-volatile food and energy prices, the core PPI increased 0.1% in March and is up 0.9% compared with a year earlier. The big story in the March PPI was wholesale food prices, which rose 2.4%, matching the biggest gain in 26 years. Prices of fresh and dried vegetables soared 49.3%, the most in 16 years.

Source: PPI

Federal Reserve "Printing" Money

NY Times details:

The Federal Reserve transferred $47.4 billion, a record sum, to the Treasury Department last year, a result of the central bank’s actions to support the fragile housing market.

The transfer to the public coffers rose roughly 50 percent, or $15.7 billion, from $31.7 billion transferred in 2008, the Fed announced on Wednesday in releasing its annual financial statements, which were audited by Deloitte.

“Central banking is a great business,” joked Vincent R. Reinhart, a former director of monetary affairs at the Fed.

Source: Federal Reserve / BEA

Leading Indicators... Growing Strength

Trying to catch up news from earlier this week. It has been a quiet economic week thus far (not many economic releases), but the latest leading economic indicators shows more signs of strength. The LA Times details:

The index of U.S. leading indicators rose in March by the most in 10 months, a sign the economy will keep growing into the second half of the year.

The 1.4 percent increase in the New York-based Conference Board's measure of the outlook for three to six months was more than anticipated and followed a revised 0.4 percent gain in February.

Manufacturers are ratcheting up production and factory workers are putting in longer hours as companies rebuild inventories and ship more goods overseas. Further improvement in the job market will help sustain the economy's recovery from the worst recession since the 1930s.

"The economy really seems to be gaining momentum, with better-than-expected data coming from a wider variety of sources," said Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit. "The sectors that were doing well appear to be doing even better and those that were struggling appear to be seeing signs of renewed activity."

And the strength excluding money supply, interest rate spread, and stock prices (i.e. eliminating the pure liquidity mechanisms and/or financial assets driven by the liquidity - though an argument can be made to include all of the leading indicators as being affected).



Source: Conference Board

More on the Housing Overbuild

Note: I will be traveling this week, thus posts will be very light / I will not be able to respond to comments in a timely manner.

Last week, EconomPic asked 'What Housing Overbuild?' showing that even during the bubble, the number of units built didn't appear to be extraordinary on a per capita basis. Reader dblwyo gave Calculated Risk a heads up on the post, which responded over the weekend with some great additional insight in the post Housing: Impact of Changes in Household Size:

If we look at a long term graph of housing starts, we notice that there were more starts at the peak in the '70s than during the recent housing bubble. If we plotted housing starts per capita, or per total households, the surge in housing starts during the last decade would not look extraordinary at all (ht Dave).

But it was extraordinary ...

He then details his reasoning as to why housing starts were extraordinary as compared to the 1970's.

The key is household formation.

Household formation is a function of changes in population, and also of changes in household size. During the '70s, the baby boomers started moving out of their parents' homes, and there was a dramatic decrease in the number of persons per household. And that lead to a huge demand for apartments (the surge in total starts).

In other words, it is not only the growth of the population that matters, but also the number of people within each house (i.e. if there were 4 individuals per house and now there are 3, you need more houses all else equal). As a result, there were too many units built this past cycle as the number of individuals in each home did not continue to contract at the same pace as it did during the 1970's.

Because of the changes in household size, the U.S. needed far more additional housing units in the '70s and '80s than in the '90s and '00s. If we could normalize the housing start chart by household formation, we would see that the last decade was indeed extraordinary!

The following chart summarizes a table he built using data from the Census showing the above phenomenon.



Using the household formation data from the Census, I was able to create the following chart, which attempts to show the normalized housing starts by household formation Calculated Risk details.

More specifically, the above chart shows the annual number of housing permits issued in each year divided by the number of households formed on average over a ten year period (i.e. the normalization part). This in theory removes some of the chicken or the egg issue as to whether:

• Households are formed, which drives building of new homes
• Building new homes adds supply, which allows new households to be formed

This revised analysis does remove the spike in permits per capita from the 1970's and shows housing builds were indeed well above the long term average of ~1.1 permits per new family* during this bubble period. But if you are going to label periods of home building that were 0.40 more homes above "ordinary" levels as extraordinary, I think you must label periods of home building 0.70 homes less than the "ordinary" level, extraordinary.

Which once again brings up my question as to the possibility that we'll go from an housing overbuild to a shortage within a 5-10 year period?

Outside of a huge reversal in the number of persons per household that may result from a prolonged economic slump, if the number of new homes remains near these historic low levels, I think it is possible.

Source: Census 1 / Census 2


* I figure the level is greater than 1 due to depreciation of existing stock (new homes to replace old housing) plus second homes.

EconomPics of the Week (4/16/10)

Must Read (if I do say so myself)
Investing in a Low Return Environment... It's All Relative

Economic Data

The Good
More on Oil's Impact on Consumption
Inventories Growing to Meet Final Demand
What Consumer Slump?
Housing Permits "Bounce"
What Housing Overbuild?
Empire Manufacturing Index Soars
CPI Remains Low... Core at Lowest Level in 6 Years...

The Bad
Consumer Sentiment Sinks in April
Small Biz Continuing to Struggle
Petroleum's Impact on the Trade Deficit
Treasury Budget and Reliance on the Private Sector
Capacity Utilization Increases (Remains Low)

Asset Prices
Goldman's Stock Crushed... All the Way to Last Month's Level
Treasury Purchasing: China + U.K. = Full Picture
China Heating Up... Consumer Style

And your video of the week... the Shins' Sleeping Lessons

Goldman's Stock Crushed... All the Way to Last Month's Level

By now, most of you have heard that Goldman Sachs was charged with fraud. So has Goldman's stock taken a hit?

As of this writing they are down 14% on the day, all the WWWWAAAAAAYYYYY back to March 2nd levels.

So is Goldman more valuable today after being charged with fraud (given the new economic / regulatory outlook) or last month pre-charge?

And people still claim the market is efficient...

Source: Yahoo

Consumer Sentiment Sinks in April

Bloomberg details:

Confidence among U.S. consumers unexpectedly fell in April to the lowest level in five months, indicating Americans are discouraged about the labor market.

The Reuters/University of Michigan preliminary index of consumer sentiment dropped to 69.5 from a reading of 73.6 in March. The gauge was projected to rise to 75, according to the median forecast in a Bloomberg News survey of 69 economists.

Lagging confidence threatens to restrain household spending, which accounts for about 70 percent of the economy. While recent figures showed retail sales picked up in March, a 9.7 percent unemployment rate and mounting home foreclosures are risks for the recovery.

Source: St. Louis Fed

What Housing Overbuild?

My earlier post regarding housing permits got me thinking... how do the permit figures compare historically on a per capita basis? I understand this isn't perfect as this is a flow (new houses added) vs. stock (total existing houses), but it was pretty surprising to me.

Surprising in that the bubble build quite frankly doesn't look that huge and surprising that we are now at extreme lows.



And vs. the 50 year average of 0.000495 permits per capita (in the chart below, the zero line is equal to the 0.000495 level).



Is it possible we'll go from an overbuild to a shortage within a 5-10 year period?

Source: Census

Housing Permits "Bounce"

Businessweek details:

Builders broke ground on more U.S. homes in March than anticipated and took out permits at the fastest pace in more than a year, a sign of growing confidence that sales will stabilize.

Housing starts climbed to an annual rate of 626,000 last month, up 1.6 percent from February’s revised 616,000 pace that was higher than initially estimated, Commerce Department figures showed today in Washington. Building permits, a sign of future construction climbed to the highest level since October 2008.

The gain in part may be due to milder weather following the February blizzards, combined with a rush to have properties available for buyers seeking to qualify for a government tax credit that expires at the end of June. The jump in permits also signals builders anticipate demand will hold up even as foreclosures climb and the jobless rate hovers near a 26-year high.

It looks like the jump in permits was solely due to the south (with new permits jumping 18% month over month).

And some longer term perspective of the "bounce".

Source: Census

Treasury Purchasing: China + U.K. = Full Picture

WSJ gets it wrong... again.

China continued selling U.S. Treasurys for the fourth straight month in February, though it remained the largest foreign holder, the Treasury Department said Thursday.

Overall, foreigners were net buyers of long-term U.S. financial assets in February, according to the monthly Treasury International Capital report, known as TIC. China remained a net seller of Treasurys, with its holdings falling $11.5 billion to $877.5 billion, following net sales of $5.8 billion in January.

Heavy Treasury sales by China at the end of last year initially set off fears that the largest creditor nation to the U.S. might be shifting out of U.S. assets. But major upward revisions to the data in late February showed that China hadn't ceded its position as top Treasury holder to Japan, as initially thought.

As detailed previously, a lot of China's purchases are through the United Kingdom, thus the "revisions". As a result, a better picture can be seen combining the two...



For full details see my previous post China Sells Treasuries... or Did They?

Source: Treasury

Empire Manufacturing Index Soars

Reuters details:

A gauge of manufacturing in New York State rose to a six-month high in April as new orders advanced and employment continued to improve, the New York Federal Reserve said in a report on Thursday.

The New York Fed's "Empire State" general business conditions index rose to 31.86 in April, the highest since October and up from 22.86 in March.

Economists polled by Reuters had expected a figure of 24.

The survey of manufacturing plants in the state is one of the earliest monthly guideposts to U.S. factory conditions. The employment index rose to 20.25 in April, the highest since March 2006, and up from 12.35 last month. New orders rose to a six-month high of 29.49 in April and up from 25.43 last month.

Source: NY Fed

Capacity Utilization Increases (Remains Low)

Business Week details:

Capacity utilization, or the proportion of plants in use, rose to 73.2 from 73 percent in February.

Industrial capacity utilization was estimated to rise to 73.3 percent, according to the Bloomberg survey median. The rate averaged 81 over the past four decades. Economists track plant operating rates to gauge factories’ ability to produce goods with existing resources. Lower rates reduce the risk of bottlenecks that can force prices higher.

Excess capacity is one reason Fed policy makers see little risk of inflation. Fed Chairman Ben S. Bernanke yesterday said the rate of increase in consumer prices was “subdued,” and said “moderation in inflation has been broadly based.” He also said economic growth will remain “moderate” as the economy contends with weak construction spending and high unemployment.

The chart below shows the historical relationship between the change in capacity and headline CPI. Please note that the below chart only reflects the change in the year over year figure, thus the 2.8% jump in CPI is the difference between the latest 2.4% print and March 2009's -0.4% print.



Another way to view it...



Source: Federal Reserve / BLS

China Heating Up... Consumer Style

We've (U.S. officials) been clamoring for years for the Chinese to shift from their export dominated economy to a more balanced economy with greater internal demand (which in theory would help the U.S. trade balance by increasing our exports to the nation). In fact, many economists have been hopeful that increased consumption by China's private sector would help offset any potential slump in demand from the developed world (i.e. U.S., U.K., and Europe). It looks like this may actually be happening.

Per the First China Invest (via FT Alphaville):

After the government succeeded in sustaining fixed asset investment, and therefore GDP growth, last year by doubling bank lending, this year it is the turn of the consumer. The one area of new lending which is still seeing significant growth this year is consumer financing, which accounted for 50% of new lending in March. As a result, new consumer lending may overtake new consumer deposits for the first time since 2007.

Good news right? Showing that nothing is easy in this world... not so fast.

After the government tightened lending to the property sector, the data seems to indicate that the Chinese consumer is tapping the consumer loan market (and even credit card balances) to not only consume goods, but also to acquire properties. This in turn is driving up home prices dramatically, which can be seen from the following data.

• We’ve just seen Chinese GDP rise 11.9 per cent in Q1.
• And urban house prices increased 11.7 per cent in March.
• And retail sales are up 17 per cent.

Lets put that 11.9% rise in year over year GDP in perspective.



Nothing the revaluation of the Yuan can't cure right?

Perhaps not.

Morgan Stanley's Andy Xie in the China Daily (via The Mess that Greenspan Made):

Actually, Xie believes that growing expectation of the yuan’s appreciation in financial markets is the most important reason for China’s vast property bubble. Massive hot-money inflows would spark excessive liquidity and speculation, fueling China’s property bubble. According to Xie, in a normal economy, currency appreciation cools inflation by decreasing import prices. However, China imports mainly raw materials, equipment, and components. A modest currency appreciation would do virtually nothing to curb inflation.

In other words, an increase in the value of the Yuan may just allow China to purchase MORE commodities, thus actually adding fuel to the already hot economy.

Interesting times...

Source: Bloomberg

Inventories Growing to Meet Final Demand

Reuters details:

U.S. business inventories rose slightly more than expected in February to their highest level in seven months as businesses restocked to meet strengthening domestic demand, a government report showed on Wednesday.

Department said inventories increased 0.5 percent, the largest increase since July 2008, to $1.33 trillion - the highest since July. January inventories were revised up 0.2 percent, after being previously reported as being flat. Economists polled by Reuters had expected a 0.4 percent rise in February inventories.

Inventories are a key component of gross domestic product changes over the business cycle and a sharp slowdown in the pace of inventory depletion is driving the economy's recovery that started in the second half of 2009.

The below chart shows business sales and production. Production accounts for the change in inventories by taking the sales and adding/subtracting the change in inventories over a given period (3 months in the chart below) to show growth in the amount actually produced to meet final sales.

It is interesting to note that while inventory levels jumped to an eight month high, the impact of inventory rebuild (or lack of depletion) on final GDP peaked in November at a 9.2% three month change and is now down to 2.0% (still quite strong) through the period ending February. As a result, impact of inventory on GDP will be MUCH smaller in Q1 than Q4 (for a full explantion go here).

Source: Census

CPI Remains Low... Core at Lowest Level in 6 Years

Marketwatch details:

U.S. consumer prices rose 0.1% on a seasonally adjusted basis in March due mainly to an increase in prices for fresh fruits and vegetables, the Labor Department reported Wednesday. The overall gain matched expectations of economists surveyed by MarketWatch. The core CPI - which excludes food and energy prices - was unchanged in March, while analysts had expected a 0.1% gain.

In March, overall food prices rose 0.2%. Bad weather pushed up fresh fruits and vegetables prices, which rose 4.6%. Energy prices were unchanged in March. In the past year, the CPI has risen 2.3%. The core rate is up 1.1% in the past year, the smallest gain since early 2004. The last time the year-over-year core increase was smaller was in January 1966. Shelter prices were down 0.1% last month.

As can be seen below, the majority of the increase remains in transportation (i.e. fuel). All other categories point to a complete lack of inflationary (and potential disinflationary) pressure on final consumption at the moment.



Source: BLS

What Consumer Slump?

Marketwatch with the details:

U.S. retail sales rose 1.6% in March, aided by strong demand for autos, building materials and new clothes. The Commerce Department said sales totaled $363.2 billion - the fifth gain in the past six months. Retail sales are 7.6% higher compared to one year earlier. Excluding autos and trucks, March retail sales climbed 0.6% to $300.5 billion. Economists surveyed by MarketWatch forecast sales to climb 1.3%, with sales excluding autos up 0.6%. Also, retail sales in February were revised slightly higher.

Source: Census

Small Biz Continuing to Struggle

While we've seen an improvement in sentiment among "big business", small businesses continue to struggle. The NFIB details:

The National Federation of Independent Business Index of Small Business Optimism lost 1.2 points in March, falling to 86.8. The persistence of index readings below 90 is unprecedented in survey history.

“The March reading is very low and headed in the wrong direction,” said Bill Dunkelberg, NFIB chief economist. “Something isn’t sitting well with small business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy.”

The index has posted 18 consecutive monthly readings below 90. In March, nine of the 10 Index components fell or were unchanged from February’s not-so-great readings.

It appears worse when looking at all the areas of small business that continue to struggle...

Employment

After a devastating period of employment reductions, employment change per firm hit the “zero line” in March. Since July 2008, employment per firm fell steadily each quarter, logging the largest reductions in survey history (35 years). The February reduction of just 0.1 per firm indicated a substantial slowdown in the bleeding, and the March reading of 0.0 confirms that workforce reductions have ended.

Capital Spending

The frequency of reported capital outlays over the past six months fell two points to 45 percent of all firms, one point above the 35-year record low reached most recently in December 2009.

Sales

The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months improved 1 point to a net negative 25 percent. Widespread price cutting continued to contribute to reports of lower nominal sales.

Disinflation

The weak economy continued to put downward pressure on prices. Eleven percent of the owners reported raising average selling prices, but 29 percent reported average price reductions.

Earnings

In March, earnings trends declined with a net negative 43 percent of owners reporting positive profit trends.

Access to Credit

Regular NFIB borrowers (35 percent accessing capital markets at least once a quarter) continued to report difficulties in arranging credit.

Source: NFIB

Investing in a Low Return Environment... It's All Relative

There seems to be a growing number of articles these days detailing the concern that rising rates will have a dramatic impact on bond performance going forward (see WSJ's The Risk of Rising Interest Rates and the NY Times' Interest Rates Have Nowhere to Go but Up). While I am less certain that rates will in fact rise over the near term (call me a contrarian), I think these articles miss the broader picture and as a result are focusing too much on rising rates rather than the issue facing investors across all asset classes. Specifically, that an investor (unfortunately) is required to take on a much higher level of risk than in the past to get any level of attractive absolute return.

But, since these articles have focused on bonds, lets focus on bonds.

Looking at the Barclays Capital Aggregate Bond Index "BarCap Agg", one of the most widely used benchmarks to represent high-quality investment grade bonds, the chart below shows the yield to worst "YTW" and the duration of the index going back 20 years. As can be seen, these two levels have crossed as the yield of the benchmark continues to ratchet down to historic lows.



Why does this matter? Well if the YTW is less than the duration, that means if interest rates rise across the yield curve by 100 bps (i.e. 1%) or more in the next 12 months, then the yield of the portfolio (i.e. carry) will not make up for the loss an investor realizes from the price impact of rising rates (this ignores convexity, but a duration of 1 roughly means that if rates rise 1%, the portfolio sells off by 1% all else equal).

Lets dive deeper and take a look at the ratio of YTW to duration. At the end of March, the YTW of the BarCap Agg was 3.46%, while the duration was 4.68 years (3.46 / 4.68 = ratio of 0.74). At this point, if rates rise by 74 bps across the entire yield curve, the price impact of the portfolio = -3.46% (-0.74 * 4.68), exactly offsets the yield of the portfolio 3.46%, thus TOTAL returns over a 12 month period would equal zero (again, ignoring convexity).

Below is a historical look at that ratio (we'll call it the Duration Coverage ratio) vs. 12 month forward returns of the BarCap Agg. Interestingly enough, the ratio has closely tracked performance. One thought is that the Duration Coverage ratio shows how much an investor is being compensated for taking risk; when the ratio is low, they are not being compensated much (thus the lower returns on a going forward basis).



So bonds are rich and duration should be avoided at all costs? Hardly.

This type of thinking made sense when one could focus solely on absolute terms. There is no question that an investor is not being compensated much in absolute terms to take on duration risk. But, this should not be a surprise when one considers return expectations for less risky investments. Shown below is the difference between the yield on the ten year and two year Treasury... it is now at historic wide levels (the green line).



As a result, while an investor is not being compensated much to take on duration risk in absolute terms (the ten year yield is low), they are in relative terms as the two year bond was yielding a measly 0.96% at the end of March. The chart below shows the same rolling Duration Coverage as the chart above with one exception... that being the YTW is adjusted by subtracting out the two year Treasury yield to put it in "relative" terms. This changes the story completely. Rather than appearing rich, the relative duration coverage now seems cheap compared to historical levels.



And THAT'S the problem with investing these days (and not just with bonds). With risk-free rates hovering near zero, an investor must take a much larger amount of risk to achieve any level of absolute return. This concept is even more meaningful for an investment in risk assets, such as equities and commodities, as the downside risks of those asset classes are MUCH higher than even the worst case rising rate scenario on an investment in the BarCap Agg.

As a result, the question for all investors should be how comfortable you are taking risk to get a return ON your capital and not just a return OF your capital?

The issue is that a lot of investors don't realize this question needs to be answered.

Source: Federal Reserve / Barclays Capital

Petroleum's Impact on the Trade Deficit

Reuters details:

Stronger U.S. demand boosted imports 1.7 percent during the month to $182.9 billion. Exports edged only 0.2 percent higher to $143.2 billion, but that was still the best showing since the depths of the global financial crisis in October 2008. Analysts had expected the trade deficit to widen in February to around $38.5 billion. The Commerce Department lowered its estimate of January's gap slightly to $37.0 billion.

U.S. imports of consumer goods such as pharmaceuticals, electronics, toys and clothing and foreign services such as travel were the highest since October 2008. Imports of industrial supplies and materials were the highest since November 2008.

While U.S. imports of crude oil was relatively stagnant in February (the average price of crude trended lower in February, but has since rebounded), continuing my higher price of oil on economic growth thought, the below chart shows the impact of the rising price of oil on the nation's trade balance.

While we have collectively import 2% less petroleum as a percent of total imports from a year back, we pay 6% more as a percent of total imports.

Source: Census

Treasury Budget and Reliance on the Private Sector

The AP details:

The budget deficit for March showed a dramatic decline as the Obama administration formally entered a lower ultimate cost for the government's $700 billion financial bailout program.

The Treasury Department said the deficit for March totaled $65.4 billion, compared to a $191.6 billion imbalance a year ago. However, $115 billion of that improvement occurred because the administration lowered its estimate of the total costs for the Troubled Asset Relief Program.

Even with the change, the administration is still projecting that the budget deficit for the entire year will surpass last year's all-time high of $1.4 trillion.

The below chart shows the year over year change in receipts and outlays. This is where things will be interesting to watch. On one hand you have receipts leveling and possibly beginning to grow (a good thing) while on the other hand you have government spending no longer being a "stimulus" to further growth.

In a nutshell... this is where private demand needs to take over for further recovery. While recent data has shown relative strength in the private sector, that strength will be even more important going forward as the public sector will no longer be relied upon for marginal demand.

Source: Treasury

More on Oil's Impact on Consumption

Last Friday, I asked "at what point does the price of oil become debilitating?".

Fortunately for me, James Hamilton attempts to answer that question. First, he points out the concern:

Ten of the 11 recessions in the United States since World War II have been preceded by a sharp increase in the price of crude petroleum. Oil had been holding around $80/barrel over the last month, but traded as high as $87 last week, leading the Financial Times to ask whether oil could give the "kiss of death to recovery."

Before we jump to his conclusion, lets take a look at what James states the spike in oil price from 2009 lows means to the consumer.

Americans buy a little less than 12 billion gallons of gasoline in a typical month. With gas prices now about a dollar per gallon higher than they were a year ago, that leaves consumers with $12 billion less to spend each month on other things than they had in January of 2009. On the other hand, the U.S. average gas price is still more than a dollar below its peak in July of 2008.

12 billion gallons per month of gasoline is a lot, but according to the EIA, total crude use is almost double the level used in gas (about 18.5 million barrels per day x 42 barrels per gallon x 365 days / 12 months = 24 billion gallons per month). Using this "total" level and comparing it to personal income based upon market prices at each point, we can see how much of a drag the spike in oil would have impacted 'consumption ex oil'. We can also see why "this time" may not be so bad... the overall level of personal income that is allocated to oil is currently not much higher than what we saw pre-crisis (and much lower than 2008 levels).



Another way to look at this data is as a change over one and two year periods.



So while perhaps not a drag, the concern I have is that the price of oil is no longer the source of "stimulus" it was when the price of oil collapsed and Americans found themselves with much more disposable income (as much as 4% more to be specific).

In James Hamilton's post, he provides details for some indirect reasons higher oil prices caused a drag on the economy as well (reallocation of capital away from American business [i.e. small cars]) that he does not see re-emerging and concludes:

So to return to the question posed at the beginning: $87 oil is certainly not helping the recovery. But I would be very surprised if it proves to be the kiss of death.

Sources:

Personal Income: BEA
Oil Prices: EIA
Total U.S. Crude Consumption: EIA