We Still See Green Shoots

This week provided some welcome relief from last week's pretty disappointing set of economic reports. Overall, indicators for the week were positive, but there were no radical changes in either direction despite a few upside surprises. Initial unemployment claims resumed their glacial improvement, while new home sales and median home prices showed improvements. Several measures of consumer confidence that were released this week were very positive.

On the business side of the equation, more regional Fed data was released that supported the thesis of a better manufacturing climate. This bodes well for the more closely watched ISM (purchasing managers') Survey due next week. Durable goods orders looked fine but were positively influenced by strong defense orders.

One negative note for the week was that the 10-year Treasury bond jumped to a 3.7% rate before backing off a bit at the end of the week. This compares with a recession low of around 2%. There is some fear that such a jump would trigger higher mortgage rates, shutting down some of the nascent improvement in the housing industry. Our take is that even with higher rates, housing still remains more affordable than it has been in a couple of decades.

Initial Claims Resume Their Improvement
Initial claims for the week came in at 623,000, a small improvement from last week's 636,000. The four-week moving average also moved down from 632,000 to 626,750. We were glad to see some improvement after last week's back-tracking. We hope to eventually see more improvement in this statistic as two major surveys of large corporations we track showed a decline in firms' intentions to lay off people.

Many of the manufacturing reports that we look at also include some type of employment outlook, and for the most part, these have shown some nice improvement off of dismal levels. As we mentioned last week, some of the auto industry and dealer layoffs are clouding the numbers a bit.

Not Seasonally Adjusted, We Have Come a Long Ways
When economists look at these claims numbers, we generally look at the seasonally adjusted numbers to account for variations in normal month-to-month seasonality (such as auto industry model changeover programs and construction firms laying off folks for the winter). The seasonality adjustment factors can be huge ranging, from 1.79 for one week in January to 0.78 for a period in August.

From an economic standpoint the seasonally adjusted numbers are the best ones to use. However, we doubt that individuals, looking at their friends and neighbors, form their impressions and spending habits based on seasonally adjusted numbers. The Jan. 10 report saw initial claims hit a high of 956,000 people, but with seasonal adjustments, that number was reported as 535,000. In this week's report, raw claims came in at 536,000 and that was seasonally adjusted upward to 636,000. In other words, raw claims have fallen by about one third from January, while adjusted claims have barely budged.

We have a sneaking suspicion that the improved consumer confidence numbers reported this week are related to individuals seeing fewer layoffs among their friends, neighbors, and family members, along with a substantially better stock market.

Consumer Sentiment Improves
Both the University of Michigan's and the Conference Board's consumer confidence numbers reported large improvements for May. The Conference Board number moved from 40.8 to 54.9, the second month in a row of large double-digit improvements and its best reading since September 2008.

The University of Michigan Sentiment Index improved from 65.1 to 68.7--up nicely from its low of 55.3 in November. The indicator has now been up five of the last six months. We believe that some of this is seeping through to the real economy, as both  Wal-Mart (WMT) and  Target (TGT) are reporting more spending on discretionary items in their stores, according to our analysts.

In general, we are not big believers in the sentiment numbers, but the extreme fear characterizing this recession has caused both consumers and businesses to react more aggressively than the raw numbers might indicate. So we welcome the improvement, as did the market, which sported a triple-digit gain the day the first set of confidence numbers were reported.

Home Sales Moving in the Right Direction, Inventories Make a Seasonal Digression
Existing home sales also showed some improvement, increasing 2.9% in April following a decline in March. The number of sales has been in a fairly narrow range of 4.5 million to 4.7 million units since December. Unfortunately, inventories crept up to 3.97 million from 3.65 million units. However, we believe that is due to more seasonal factors (homes tend to go onto the market in the spring) and perhaps an end to some foreclosure moratoriums than anything else. We are still well below the 4.58 million unit peak but above a normalized inventory level of 2.5 million units.

On the manufacturing side, durable-goods orders showed an increase of 1.9%, primarily due to a hefty increase in defense spending. Ex-defense and aircraft, orders were down 1.5%, which was still a little better than expectations. Frankly, it is a little early in the cycle to see improvement in this usually late-moving series.

2Q GDP May Be Meaningfully Better Than 1Q
Putting it all together, we continue to expect the consumer, autos, and housing to ultimately pull us out of this recession. We think the second quarter is likely to see GDP decline at a much more modest 1%-3% versus the 5.7% decline reported for the first quarter (during the week of May 25, the first-quarter figure was revised upward from an initial reading of negative 6.1%). A smaller inventory adjustment, higher government spending, and a decent--if not robust--consumer will drive the improvement, while construction spending and capital goods will remain in the doghouse.

Going forward we expect the stimulus program to kick in shortly. And it can't come soon enough, as some of the consumer gains from gasoline and lower interest rates begin to reverse themselves over the next couple of months.

Jobs Report Ahead
All eyes will be on the jobs reports the week of June 1. We are expecting a relatively flat number versus last month's job losses of 539,000 as the private sector experiences fewer job declines but we lose the bump we got from the hiring of government census takers last month.

Earlier in the week, we will get the ISM manufacturing numbers, which we expect to show further improvement from April's 40.1. However, there are some early signs from the regional data that the new orders component of the index may not be as robust as it has been the last several months.

Next week's personal consumption numbers will also prove interesting, especially in light of the below-expectations retail sales numbers reported a couple of weeks ago. We'd bet that the services component will help push the overall consumer consumption number (goods and services) into positive territory for April, but it's a coin-toss at this point.