Betting with Buffett

Overall, it was an excellent week for the economy. The only fly in the ointment was Friday's exceptionally hard-to-interpret employment report, which showed unemployment bolting past the 10% barrier amid reports of higher-than-expected job losses.

Now, before the doom-and-gloom pessimists let loose a cathartic burst of "I told you so," consider this: Individual components of the release, and a more nuanced view of the data, showed some bright spots.

I have never been a huge fan of the monthly job report, so I was glad to see other important employment indicators paint a more flattering picture of the employment landscape. These include the Challenger Gray and Christmas Layoffs Report, the employment component of the ISM purchasing managers report for manufacturers, and the ADP Report. Shockingly, the market seemed to agree, and reacted far more favorably than I might have expected to Friday's numbers.

Buffett Goes 'All-In' on Economy
News from the construction, real estate, manufacturing, and retailing sectors was better than expected. In the corporate world, merger mania continued this week, as  Black & Decker  and  Stanley Works (SWK) agreed to merge, as did  Berkshire Hathaway (BRK.B) and  Burlington Northern . The Berkshire purchase was interesting, as Warren Buffett proclaimed it to be "an all-in bet" on the U.S. economy. Given the wide variety of goods shipped via rail, I think Buffett's assessment is correct. After his favorable comments on the economy last fall in the New York Times, I am glad to see Buffett put even more money where his mouth is.

Heightened merger activity. Huge and continuing productivity gains. The auto and housing industries operating far below normal replacement trends. I think these data points all suggest huge medium- to long-term potential for the U.S. economy from today's levels. While I admit to a modest fixation on the short-term numbers, it is important to keep the long run in perspective.

The Productivity Impact
The productivity numbers this month were truly stunning, with output per hour increasing more than 9.5% on a seasonally adjusted annual rate basis.

While gains like this aren't unusual coming out of a recession, productivity never declined as much during this recession as it did during many prior recessions. Increased productivity has thrown cold water on job growth in the short run (almost by definition, productivity is producing more with fewer hours of input). But in the long run, productivity allows goods to be priced more attractively, stimulating demand both in the U.S. and abroad.

Productivity has improved much more rapidly in the U.S. than in any other developed market, with the exception of Korea. Combining sky-high productivity with a falling dollar, the U.S. export position may be in far better shape than what is built into the consensus view. In addition, better prices free up consumers' cash that can now be used to buy other goods, stimulating overall demand. High productivity in agriculture has allowed prices to fall, causing consumer spending on food to shrink dramatically over the last 30 years. This frees up more dollars to spend on such things as electronics and health care.

Autos Rolling
In shorter-term positive news, auto sales in October rebounded from September's poor showing (due to the expiration of the Cash for Clunkers program). Edmund's reported preliminary auto sales for October at 10.5 million units, well above the 9.2 million units in September, and not too far off the 10.8 million units sold a year ago. So, despite dire warnings about pulling business ahead, October sales were higher than any other month of this year, except for the clunker-induced peaks during July and August. In fact, even September's sales were above the February low.

The auto industry still has a long way to go to get back to the 16-18 million unit production level that is typical of normal times. Even a move halfway back to normal levels, perhaps 12 million units, could provide a nice tailwind. Morningstar auto analysts David Whiston and David Manger, our auto analysts, also passed along positive comments from Michael Jackson of  AutoNation (AN). Jackson expressed a high degree of confidence that auto sales had hit the recessionary trough in February. Just as importantly, he indicated that AutoNation and other industry participants had managed to cram three years of restructuring into just one year.

So, as sales come back, industrywide profitability could improve dramatically.

A Closer Look at the Jobs Report
The employment report was a mixed bag. The 10.2% (versus 9.8% last month) headline number is bound to rattle a few consumers, but I have warned for many months that this number was likely to increase through early next year. I still think the rate will stay below the 10.8% level of the mid-70s and early 80s recessions.

Far more important from an economic point of view was the job loss number that came in at 190,000 instead of my estimate of 160,000 to 170,000. However, the Labor Department moved the goalposts on me. The job losses for August and September were revised downward (smaller losses) by almost 91,000 jobs, overshadowing my 25,000 miss for October's losses.

There were a lot of other positive surprises under the hood, too. Temporary employment, which is a reliable leading indicator, increased by 44,000. Finance and information services and government were all pretty much flat for the month. The larger losses this month were mostly confined to construction, manufacturing, and retailing.

The average hourly wage ticked up a nickel. That translates into a 3%-plus annual rate at a time when inflation is muted. I believe this to be more of a mix shift issue (retailing, which was weak, is not a high payer), but it will still help the overall wage statistics.

Overall hours worked were flat at 33.0 while the more important manufacturing sector hours were up 0.1 hours and overtime also crept up. Given that the ISM manufacturing employment index improved dramatically, I suspect either employment or hours or both could show even better improvement next month. Weekly initial unemployment claims retreated by 20,000, one the biggest improvements this year. The new claims level hasn't been this low since January. The week covered by the initial claims report came after the monthly employment survey was taken, and will be counted next month's employment numbers.

Consumer Update
For the last few weeks I have been talking about the need for improving consumer spending trends. Weekly chain store sales compiled by the International Council of Shopping Centers notched its sixth straight week of sequential improvement. In addition, many retail stores reported same-store sales on Thursday, and with the exception of teen retailers, same-store sales trends were generally above expectations.

Retailers are now up against some very depressed comparables from a year ago, but it was still nice to the see a positive sign on the year-over-year data for the first time in months. Also of note, two high-end retailers,  Saks  and  Nordstrom (JWN), managed to finally show positive comparisons, joining the ranks of discount retailers such as  T.J. Maxx (TJX), and  Ross Stores (ROST), which have been showing better comparisons for some time.

Stronger stock market performance has often been associated with more robust holiday spending (whether this is cause and effect or coincidence is a matter for another debate). Some better numbers from the high-end retailers in October holds out some hope that retail sales this holiday season may surprise to the upside, versus the current expectation of a flat or slightly down season. My guess is that the retailers will do better than this. If seasonal sales don't improve, low inventories and inadequate sales help could be bigger factors than consumer demand.

Next week is a very light week for new economic data, with just the trade balance and one of the bimonthly sentiment indicators due on Friday, along with the weekly initial claims report on Thursday. 

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