(By Robert Johnson, CFA) The economic news this week was shockingly good--almost too good to be true. Just as the economic indicators in August and October were just too bad to possibly reflect reality, December numbers, while excellent, probably include some statistical tailwinds.
Housing starts hit a recovery high, housing prices jumped more than 7% in 2012, inflation remained tame, and official retail sales refuted previous rumors of a disastrous holiday season. Manufacturing even looked better as industrial production had its second large improvement in as many months. (However, year-over-year data seems to be forming a rut at about 3% manufacturing growth.)
Initial unemployment claims hit a new recovery low, but massive seasonal factors provided a bit of a tailwind. And while difficult conditions in Europe remain (Germany's fourth-quarter GDP was very disappointing), China looks to be accelerating off its bottom with a fourth-quarter GDP estimate (year-over-year growth of 7.8%) higher than third-quarter (7.3%) growth.
Earnings data so far has been mixed with great news out of General Electric (GE), mediocre data for banks, and disappointing news out of tech bellwether, Intel (INTC). It still looks like earnings growth in the fourth quarter will handily beat the zero growth rate of the third quarter.
Even Congress seemed to be more willing to cooperate on debt ceiling issues, giving the market another reason to cheer on Thursday and Friday. About the only thing to rain on this week's parade of economic news was more Dreamliner problems at Boeing (BA). Boeing isn't turning off production just yet, so I am not panicking. However, Boeing is at least a portion of the optimism on U.S. manufacturing and export sectors, as it has been over the past year.
I am still exceptionally bullish on the U.S. economy, but I still don't think we are going to rocket up at a much higher rate, either. Low inflation, a rapidly improving housing market, and now recovery in China are reasons for my short- and medium-term optimism.
Unfortunately, I have to post GDP forecasts by quarter, and the news here is still a little rough. After growing 3.1% in the third quarter, fourth-quarter growth could come in at about 1.5% with the prospects for the first quarter being about the same. The fourth-quarter "slowdown" is related to ups and downs in government defense spending, soybean shipments, and auto industry seasonal shifts. Hurricane Sandy isn't helping matters, either. Core economic fundamentals remain the same with employment growth rates nearly identical in the third and fourth quarters. The first quarter is likely to see at least a small impact from the return of a higher payroll tax rate as well as delayed tax refunds. Despite these near-term stumbles, I am not in any way reducing my economic forecast for the entirety of 2013, as I published in my quarterly Economic Outlook.
No, the U.S. Economy Has Not Been Fragile After All
Although most economists got at least some things right about the U.S. economy over the past two years, the one nearly universal error was the expectation that the economy was fragile. The U.S. economy has proven to be anything but fragile.
I believe this to be the single biggest error that economists have made over the last two years. During that time, the U.S. has survived the fallout from a major debt crisis in Europe, a divisive election, temporarily going over the fiscal cliff, gasoline prices that have been on a yo-yo, a tsunami in Japan, and Hurricane Sandy, which shut down New York and even the stock exchanges for a couple of days. These are not signs of a fragile economy.
The U.S. Economy Resembles a Slow-Moving Ocean Liner
Looking at a lot of the economic statistics month to month, you would think we are in a very volatile world, especially if you only looked at month-to-month or quarter-to-quarter data. However, averaging data over several months and looking year over year, the economy has been remarkably stable.
Consumer spending and employment have been in very narrow (and slow-growing) bands for more than two years. The truth is consumer incomes have increased modestly and U.S. consumers continue to spend most of what they make, forcing manufacturers to make more and hire more, which in turn increases consumer incomes. Then the whole virtuous cycle continues until inflation wrecks the party.
In the U.S., the consumer makes up 70% of the economy, even before I add in consumer investment in housing. That's why my eye is always on the consumer and what he is actually doing. My other eye is on inflation. We have a lot of news on both fronts this week.
The Official Retail Sales Report Confirms the Holiday Season Was Good, Not Great
The official 0.5% growth rate in total retail for December took investors by surprise as most estimates centered on a more meager 0.1%-0.3% rate. Apparently consumers were not scared off by the fiscal cliff after all. Automobiles, furniture (driven by strong housing activity), drugstores, restaurants, and apparel all registered monthly gains of more than 1%.
Meanwhile, falling prices caused declines in reported sales of gasoline and electronics. Outside of apparel it really wasn't a very typical holiday season, with cars and furniture doing well even as traditional department and discount stores hardly saw any growth at all.
I mentioned earlier that some reports weren't quite as good as they looked, and this was certainly one of them. While the month-to-month number was very good, and it did manage to beat consensus, the year-over-year numbers were still a little anemic, as shown below.
Keep in mind that Hurricane Sandy had a large effect on the data for October, and that affected the three-month average for October, November, and December. The data series should lift a little in January as October disappears from the averages. Keep in mind that the table below also excludes autos, which did particularly well December. And sometimes when consumers are buying autos and houses, there is less money and time to shop for other items.
For more data on the retail sales reports see our video.
Outstanding Inflation News Continues
As I implied in my opening, the surest way to get into a recession is to have rapidly rising inflation. That was nowhere in evidence in the government's Consumer Price Index, which declined for a second month in a row, with the CPI down less than 0.1% for December compared with November.
Four major categories were down: gasoline, medical-related goods, used cars, and apparel. Items seeing increases included airline tickets, which are now on a multi-month run, natural gas, and medical services.
Food prices were still up, but it now appears the consumer food prices are tracking down (unless things get even worse in California, weather-wise). Food prices were up just 0.2% in December following a 0.3% increase in each of the prior two months. The Producer Price Index for food was down yet again in December, which is the basis of my optimism regarding food prices.
Unfortunately, gasoline prices are probably headed higher this spring as recent crude oil price increases will eventually work their way into higher gasoline prices. Therefore, it doesn't seem like more deflation is in the cards for the near future.
While the month-to-month inflation result was stellar, the year-over-year, averaged data was only slightly better than the previous month. However, on a broader perspective, the current inflation rate is just shy of half the median rate (1.9% actual compared with 3.6% median) and is in the bottom 13% of all monthly inflation readings since 1970.
CoreLogic Expects Home Prices Were Up 7.9% in 2012
Early this week, CoreLogic (CLGX) announced that its Home Price Index was up 7.4% from November 2011 to November 2012, the biggest increase since 2006. Year-over-year prices were up in all but six of the 50 states. Prices were even up month to month during this normally weak period. Based on CoreLogic's database of pending home sales, it is now projecting full-year prices will be up 7.9% for the year ended in December. Including the estimated December data, year-over-year prices have been up for 10 months in a row with no end in sight. I have averaged the last three months of CoreLogic data below to smooth out some of the monthly bumps.
Housing Starts Crack the 900,000 Mark
Housing starts, which are always volatile, blew away almost all economists' expectations, coming in at 954,000 units compared with just 851,000 the previous month and expectations for 883,000 units. The strength was geographically dispersed and included nice pickups in both single-family homes and apartments.
These dramatically improved starts have yet to have their full effect on the economy. While starts are up a dramatic 25% year over year, three-month averaged, houses under construction are up a more lackluster 18%, and completed homes are only up 16% for single-family homes. It is only when a home moves into the final stages of construction that it begins to dramatically affect the economy.
While this is outstanding news and speaks to the health of this important part of the economy, it probably comes just a little too late to dramatically boost the fourth-quarter GDP back up to my original 2% forecast. Looking ahead, my once dramatic-looking forecast of 1 million or more units for all of 2013 now looks like a chip shot. In fact, one economic workshop that I respect, Capital Economics, normally a bastion of conservative thinking, is now talking about starts of 1.4 million units by the middle of 2013. The estimate was reported at the very end of this Wall Street Journal article.
The bad news is that the current housing starts reading is still well below 50-year averages (about 1.5 million units started). However that's the good news, too. Starts have now doubled off of the bottom but there is still a massive amount of runway in front of us for further expansion. The plane has now set its new direction and is picking up speed. It will take a lot to stop the momentum that has now been unleashed.
After This Week's Massive Data Flow, Slim Pickings for Next Week
The economic calendar for January has alternated between a week of huge data flows followed by a week with almost no data. This week we had data on almost every element of the economy and next week all we have is a couple of pieces of housing data.
On Tuesday, we get existing home sales for January, and expectations are high at 5.1 million annualized units closed. Recall that existing home sales increased to 5.03 million units in November, the first time that metric crossed above 5 million annualized units since the recovery began in 2009. In fact, one would have to go all the way back to 2007 to find a higher selling rate.
Pending home sales, which are often a good lead indicator of existing home sales, did improve in the latest reading. However, there won't be a Hurricane-Sandy-related bounce in December and weather was less than ideal. And in December, we were at the peak of worries about the fiscal cliff. One final concern: Inventories are so low in some markets, there is now no business to be transacted.
More Positive Home Price Data and OK New Home Sales Due
New home sales and home price data from the housing finance agency are also due next week. With the strong home price data from CoreLogic discussed above, there isn't a lot of mystery left in what happened to housing prices in both November and December. I suspect the year-over-year FHFA Home Price Index will be up in the 6%-8% range from November to November, telling us what we probably already know, namely that home prices have clearly bottomed and have now moved enough to make consumers feel much better about their financial position. New home sales for December are expected to be relatively flat with November sales at 385,000 annualized units. Again, some of the issue is the availability of homes and land available for sale.
Overbuilding, Easy Loans Fueled Boom, Led to Housing Collapse
Cheap loans for anyone who can fog a mirror contributed to dramatic overbuilding and unsustainably high prices during the early part of the last decade. The market collapsed as that easy financing was withdrawn and prices fell dramatically. However, the normal tonics of low prices and cheap credit weren't enough to bring the market back.
Kids Moving Home Held the Housing Recovery in Check
Young adults moved back home in hordes, cutting off the beginning the homebuying cycle (which begins with renting a place). Basements across the nation filled up with unintended residents, with mixed feelings from both parents and children. That trend is now reversing as those young people built up some savings and moved from unpaid internships into real jobs. Much to the relief of parents, those kids are moving out in droves. (I am a little biased here. My daughter just moved out, and a number of my neighbors I have been writing about in past columns have also lost their basement dwellers in the last few months.) Now that the balance between the number of kids moving back home and those who are moving out has swung back to more normal, balanced levels, housing demand should begin to reflect population growth rates (not population growth less a huge number of net movebacks).
Either Prices or Starts Need to Go Up Dramatically to Meet This New Demand
I think the housing market has entered the stage where we have entered a self-fulfilling, virtuous cycle where the individual data points are less important as long as there isn't a major economic shock. Right now we seem to be in a stage where prices have to go up to bring in more supply (from both builders and current owners). If more builders don't start building more homes and if more homeowners don't put their homes up for sale, home prices will begin to accelerate, perhaps dramatically. This could really pump up the consumers who already own homes. On the other hand, housing starts could move up strongly, helping put hundreds of thousands of construction workers back to work. However, the trade-off is that home prices won't move up quite as fast. I am not quite sure which option to hope for.