(By Robert Johnson, CFA) Very early signs of a stronger world economy and decent if not downright boring earnings releases (unless you were an unfortunate Apple
) shareholder) combined to drive the market higher every day of this week.
The economic news was thin, most of it housing-related, most of it continuing to demonstrate good long-term trends. Nevertheless, there's nothing new and exciting to write home about for the month of December.
The sleeper piece of economic news that came out of nowhere this week was a dramatic fall in initial unemployment claims that really cranked up the rumor mill concerning the January employment report due next Friday. After puttering around in the high 300,000s for most of 2012, unemployment claims fell to 335,000 last week and 330,000 this week--both recovery lows. Even the four-week moving average made a breakout low to 351,750 claims. Seasonal adjustment factors were surely a big help and the timing of Martin Luther King Jr. Day could have caused some dislocations in the data. Still, the dramatic change did catch the market's attention.
Also helping markets were lots of remarks from politicians, bankers, and CEOs that seemed to suggest that the worst of the European crisis was behind us and perhaps things were picking up a little. The Markit Purchasing Managers data seemed at least modestly supportive of those statements, although the improvement in Europe was based mainly on news out of Germany (which is in turn improving shipments to China).
What does this mean for the United States?
The U.S. economy (and its stock market) was one of the best performers in 2012 despite worldwide softening. But I am not going to turn around and say that a much-improved world economy will set the U.S. economy on fire. That said, better world news means fewer headwinds, greater confidence, and probably scratching the euro demise off the worry list, at least for another year. Also, corporate earnings might look a little better with improving world economies, even if that doesn't necessarily translate into more jobs for U.S. residents. Unfortunately, it could mean higher inflation, too.
World Data Shows Reasons for Optimism
Although manufacturing is not the linchpin of the U.S. economy, it is an extremely important sector in many parts of the rest of the world. Markit/HSBC Purchasing Manager Reports suggest that manufacturing news is getting better across major markets. The flash reports issued this week showed many major markets at multi-month highs, with the more predictive new orders indexes indicating more good news ahead.
A stronger housing market, in addition to an already strong auto market, is helping along the U.S. index. This favorable report bodes well for next week's U.S. Durable Goods Report and the more widely used ISM Purchasing Managers' Report.
Existing-Home Sales Take a Pause
Last week I argued that there were as many negatives (a dearth of Hurricane Sandy help, bad weather, fiscal cliff) as positives (pending home sales, consumer incomes, massive move the prior month) influencing the existing-home sales report for December. We got the final answer this week and the news was little changed, as existing-home sales went from 4.99 million units to 4.94 million units, both well above October's 4.76 million level and the 4.67 million average for all of 2012. On a three-month average basis, sales growth continued to accelerate, reaching 12.1% in the month ended December, the best rate of 2012. Adjusting for price, the news was even better: year-over-year transaction value crossed the 20% level and reached 22.5%. A general rise in home prices is providing some of that lift (prices were up 6%-8%) as well as a mix shift to higher-end homes (or more likely, slower growth in low-priced foreclosures).
Not surprisingly, the bears were all over this report, trumpeting the month-to-month decline. The only surprise to me was it took this many months to see any kind of decline at all, and this one was truly tiny. Given non-cooperative weather, a few more sloppy months wouldn't surprise or scare me, either. Low inventories are likely to take a bite out of sales, as inventories took another dive in December, though that number is not seasonally adjusted. At 1.8 million units for sale, inventories are lower than they have been at any time since 2000 and way down from the high of just over 4 million units for sale in 2007. Even at today's reduced selling levels, inventories stand at 4.4 months of supply, approaching the low end of a normal 4-6 month range. However, those low inventories may cause prices to continue to levitate as more people compete for fewer available houses.
FHFA Confirms November Home Price Increases
Speaking of prices, the FHFA home price indexes showed a monthly 0.6% increase in prices and a 5.6% increase between November 2011 and November 2012. Prices were up year over year in every one of the nine regions with growth ranging from 0.5% (Mid Atlantic) to 14.8% (Mountain). On a month-to-month basis, prices were up in seven of the nine regions. The government noted that national prices have not declined on a month-to-month basis since January 2012. The data is consistent with reports from CoreLogic (CLGX) two weeks ago and should be just modestly higher than the price growth that Case Shiller will report next week. Really tight inventories seem to indicate more upward progress in home prices in the months ahead. While home prices likely grew in the 6%-7% range in 2012, I think that 7%-9% growth is a real possibility in 2013.
Mixed Bag From New Home Sales Report
On the surface the new-home sale report looked like a bad deal. The headlines crowed a 7% decline in new-home sales for December compared with November. That doesn't sound good. Peeling back the covers, there were positive adjustments to prior months, including a massive 30,000 increase for November. So the actual number for December was 369,000 units sold compared with the recovery record of 398,000 in November.
Given some decent starts numbers recently, I suspect there may eventually be upward revisions in the cards for December, too. My slightly more reliable year-over-year, three-month averaged numbers still looked decent at 15.5% growth (and the likelihood of an upward revision is very high). And builders have sold out of low-end homes, so the average transaction value continues to far exceed the unit growth. Transaction value growth exceeded 25% in each month of the last six.
Last week, a lot of readers astutely commented that housing starts were doing wildly better than new-home sales. Starts have almost doubled during this recovery while new-home sales are up about a third. This isn't quite as diabolical or wrong-headed as it may seem. The biggest difference between the two series is that new-home sales only reflect single-family homes while the starts reports include a range of single-family homes to giant multifamily apartment buildings. The non-single family home count has more than quadrupled from 75,000 units at the bottom to 306,000 units currently. Single-family starts are up an impressive but more modest 66% from their lowest levels to about 508,000 units. It's a little easier to gear up to build large quantities of apartments than it is for single-family homes. And as mentioned last week, a lot of the real action in the housing market now is young people moving out of their parents' basements. Most of those people are moving into apartments.
But there are still houses and some growth that is seemingly unaccounted for. Single-family sales are running about a 380,000 pace (three-month average) while single-family starts are running at about 592,000. The difference here is custom homes that are built on land owned by an individual with the builder contracting to build the house. The new-home sales report intentionally excludes these homes. The new-home sales total also excludes homes that builders constructed for themselves (actually this is fairly common, with the builders staying just a short while before selling, almost like a furnished model home for small builders). Working the other way, the new-home sales report includes homes that were finished months ago and are just sitting completed but unoccupied in addition to homes that have not even been started. For these reasons, I am not a fan of the new-home sales report.
However, the new-home sales report does bring to light what may be the key impediment to the real estate economy, namely a shortage of resources (land, materials, and workers) to build new homes. Builders have worn down their inventories of land and some of the land and developments that they do own are not well positioned given relatively high gasoline prices and demand from younger people who may not want to live in the sticks. We know there has been some activity on this front, with larger builders buying smaller builders to get access to land. And I have also heard stories of builders buying tear-down properties, en masse, for the building of new homes. The shortage is also showing up with builders constructing bigger, more expensive homes on the land they do own. The percentage of homes sold for less than $300,000 has slid almost 10% in just one year, while more expensive homes continue to take builder share.
Weekly Data Seems to Indicate No Early Disasters from Fiscal Cliff
I usually try to keep weekly data out of these reports (though I do watch them like a hawk) to keep out some of the noise and volatility. However, I am now desperately looking for early readings on how higher taxes and more potential fighting on Capitol Hill may impact consumer spending. Tax refunds will go out later than usual, too. The auto data next week should help sort out some of the situation. Until then, the weekly news has been good. Shopping Center data from ICSC have continued to show year-over-year growth of 3.0%-3.5% (five-week average) for all of January, which is smack in the middle the 2.5%-4.0% range that has persisted for the last two years. No cliff here.
Initial claims also hit another recovery low for the second week in a row. Seasonal factors have been blowing in our favor all month, but now we seem to have back-to-back conformational reports, despite a much smaller seasonal factor in the latest week. I still think the statistic will bounce back some in the weeks ahead, but again, there is certainly no indication that we are falling apart, based on this piece of employment news.
Next Week Loaded With Data
Next week we get a ton of economic data, some of it too old to be relevant, some of it repetitive, but some of it will manage to be at least modestly informative.
Economists will be looking very closely at the employment report for January and many are excited about the possibility of an upside surprise. Two record recovery low weekly initial unemployment claims reports, very low Challenger Gray layoff reports, and positive seasonal adjustment factors all have economists salivating over the possibility of a stronger-than-expected report. Currently, the official posted estimates are for employment growth of 158,000 versus 155,000 the prior month. Recall that for the full year, I am hoping for job growth of just under 2%, which equates to about 175,000 jobs per month. I think continued growth at this level would bring the unemployment rate down to just over 7% by the end of the year.
Unfortunately, as excited as everyone is about the report's potential, there are headwinds, too. Remember, there was an unusually large amount of retail sales hiring this holiday season, and an above-average number may leave in January. The volatile courier segment has also done odd things to the December and January reports. A return to more normal weather conditions could also temporarily hurt the numbers for firms that are dependent on decent weather (think construction).
The key thing to remember is never get too wrapped up in just one report. I have a relatively high degree of confidence that the year-over-year employment growth average over three months will continue to show growth of about 1.8%. With continued improvement in the residential housing market, there is the possibility for at least modest improvement over the year ahead.
Expectations for Seasonal Adjusted Auto Sales Are High
January auto sales will provide the first hard data on how the consumer is reacting to the higher payroll taxes and how other new taxes are affecting consumers. I suppose the numbers could be helped a little by the temporary resolution of the fiscal cliff and by what I expect to be very good personal income growth in December. Expectations seem relatively high, 15.2 million seasonally adjusted units, compared with a relatively robust 15.3 million units in December. Without any knowledge of the actual numbers so far in January, this just feels too high. Some of the positive after-effects of Sandy will begin to wear off and November and December seemed unusually high already. There is always the hope of the massive seasonal adjustment factor saving the day (January is normally the slowest car month of the year, so the seasonal adjustment factor is huge). I would be very happy with any number above 14.9 million. My full-year forecast is for 15.0 million-15.5 million units, so even a slightly sub-15.0 million unit reading for January could be very satisfying.
GDP Report Will Have a Lot of Quirks and Will Not Provide Much Insight
About the only good news about the GDP report for December is that expectations are exceptionally low with the average being 1.0% versus September's unusually strong 3.1%. The report will be a mess and easy to construe as negative. From my point of view, if consumption (which represents 70% of the report) is above 2%, I will be a very happy camper and the rest of the report is noise.
My forecast for consumption growth of well over 2% represents an acceleration over the third quarter's 1.9% growth rate. Falling inflation and rising incomes should drive this consumption figure with autos being a big help. The decent consumption numbers come despite the negative impact of Hurricane Sandy at the beginning of the quarter and unresolved fiscal cliff issues at the end of the quarter. In fact, these two events probably will end up taking off a quarter to a half-percent from the report.
The negative quirks in the report are likely to include a huge swing in defense spending that added 0.7% to GDP in the September quarter and could take away the same amount in the December quarter. Imports and exports reported in the fourth quarter so far would suggest a modest hit from an increasing trade deficit. The key to exactly how bad the hit is will be determined by the government's estimate of December trade figures (the actual figures won't be available for another two weeks). Given the massive one-month spike in imports for November, it's difficult to guess what the government might estimate for December. However, if trade turns out to be an issue, we usually get at least a small offset in the inventory accounts.
From available data, it's highly unlikely that the fourth quarter will be a GDP barn burner. However, the 1% consensus seems too low. I don't think we will get all the way back to my original 2.0% forecast for the quarter, but I think that 1.5% is achievable.
Personal Income Should Be Stellar, but It's Kind of Old News
A lot of people have wondered where some of the holiday strength came from, and I would strongly suggest it was a combination of better incomes and lower inflation. From the employment report issued weeks ago, we already know that employment levels, hours worked, and hourly wages were all up, so incomes should be way up for December, for the second month in a row. Unlike November, which saw deflation, the U.S. will have no inflation or deflation for December. I suspect the consensus estimate for personal income of 0.8% will end up close to the actual report. The accounting for all the special dividends issued in December could potentially provide a further boost to the report.
My personal belief is that the income report is really old news. The employment report gave everyone most of what we needed to know about consumers weeks ago. As good as the report is likely to be, next week's employment report for January, not the personal income report for December, will be the provider of fresh news.
Consumption Growth Expected to Trail Income Growth; I'm Not So Sure
The consumption report for December is expected to grow considerably less at 0.3%, indicating expectations of a considerable increase in the savings rate. Frankly, I think the 0.3% rate looks a little low as the retail sales report for December was up 0.5%, and that 0.5% included large price decreases for gasoline, electronics, apparel, and new and used cars.
Lots of Other Data Due Next Week, and It Should Range From Good to Great
Next week we get more manufacturing (ISM PMI, Durable Goods), housing (pending home sales, Case-Shiller Prices), and construction news. The consensus for all of these indicators is a meaningful improvement based on data received earlier in the month (CoreLogic home prices and Markit Purchasing Manager data). Unless one of these is terribly out of whack, I don't think any of them will move the market much. I suppose pending home sales might be the most meaningful of the lot because it will help to determine if the shockingly low housing inventories reported above will dramatically slow purchase interest. Potentially, the construction report will help to determine if the commercial building sluggishness is continuing despite a much more robust residential housing market.