Tune the Static Out of Monthly Data

This week, a broad range of economic indicators looked relatively soft compared with the previous month, but impressive versus figures from a year ago. There were no disasters in any of the data, but after a few months of truly impressive growth, this batch of statistics looked lackluster.

Manufacturing data looked weak, but that's after several months of results that were off-the-charts good. Housing data looked flat month-to-month, but year-over-year, the data looked respectable. Despite overall lackluster housing data, most reports showed reduced home inventories and higher prices even if volumes still remain pathetic. Weekly unemployment claims continued to edge up, at least partially due to seasonal factors that have become more onerous.

Only the retail sales report was unequivocally good, with strong month-to-month improvement in almost every category and steady year-over-year results. If I had to pick just one report to be stellar, this would be the one. Better sales will eventually drive more production and employment that might eventually trickle down to the housing market. The market's current fixation on manufacturing is truly misplaced, in my opinion. Production will follow spending and not vice versa.

There was a lot of earnings news during the last couple of weeks, but no easy way to characterize all the results. Financials seemed a little soft, and for all the moaning and groaning, manufacturing results looked OK, led by some nice results at  GE (GE) on Friday. Europe and China certainly aren't helping matters (though we haven't heard of any overseas disasters, either), but so far most weakness in those markets has been offset by strength elsewhere. And even the China results aren't uniformly bad with  Yum Brands (YUM) seeing some of its  best results in years.

If there was one theme that I heard across our teams this week, it was that company-specific issues (such as product cycles and production hang-ups), not the overall macro economy, are driving good and bad earnings reports.

Industrial Production Analysis Depends on Your Point of View and Your Time Frame

Viewing the data on a month-to-month, seasonally adjusted basis versus a year-on-year basis averaged over three months gives two entirely different answers about the health of the manufacturing sector.

Looking at the manufacturing-only portion (which excludes utilities, hurt by bad weather; and mining) on a month-to-month basis, it appears that the manufacturing sector is in a free-fall with annualized growth falling from almost 18% in December to an outright decline of 3% for the just-reported month of March. The year-over-year, averaged data (the un-averaged data isn't much different) shows a small increase from 4.5% to 5.5% over the same few months. What gives? 

First off, the 5% year-over-year report seems quite consistent with personal consumption of goods growth of 3% and increasing exports. So on the surface, it is the monthly numbers that look suspect. The single-point 18% jump in the month of December seems to bear no resemblance to reality. Instead that huge jump reflects the auto industry returning to normal after tsunami-related supply-chain issues. 

Outdated seasonal factors, an ever-increasing emphasis on end-of-quarter shipments, and amplifying minuscule changes by annualizing them make monthly data relatively worthless, if not laughable. However, it can be useful to tease apart the strong and weak sectors on a monthly basis to determine if any particular sector is driving the figures.

The news on the sector front was not as good. Even in the year-over-year data, just four industries accounting for 27% of the manufacturing sectors' output produced 60% of the growth. Not surprisingly, autos led the way, but fabricated metals, aerospace, and machinery turned in stellar performances, too. Overall, it appears that the manufacturing sector has become quite dependent on autos and aircraft.

Meanwhile, both the printing and paper categories showed year-over-year declines, and chemicals and apparel barely inched above the zero mark. Sector performance was little changed between the three months ended in December and the three months ended in March. If one looked hard, durables were a little weaker, but still very strong, while nondurables looked a little better in March than December, but were still growing slowly.

Housing Data Still a Bit of a Muddle
There was a lot of housing data this week, but none of it added any clarity to the state of the housing market. Month-to-month numbers were basically flat as expected, because warm winter weather pulled ahead some business that normally would have fallen into the spring months. That in turn dampened the typical spring rebound we would normally see as shoppers come out of hibernation. Our normally helpful year-over-year numbers remain robust, but those numbers are suspect, too. Last year was unusually cold and this year was unusually warm, making the comparisons easy, to put it mildly.

Reading between the lines, I think the housing market remains off its bottom, but a painfully slow recovery continues. Things aren't accelerating, and the market slowly trudges ahead with the indicators seldom rising or falling in tandem in any given month. At the moment, pricing and inventory data are looking particularly supportive while existing home transactions and housing starts appear stuck in the doldrums.

Adam Fleck of our Housing and Industrials team commented on this week's housing reports:

Existing home sales fell slightly month to month, but we're encouraged by continued inventory shrinking. We had previously written that strong existing home sales growth in the first two months of 2012 were likely the result of better year-over-year weather conditions, and March's 2.6% sequential decline seems to bear out this thinking. That said, we note that the seasonally adjusted annual rate of sales still climbed roughly 5% year-over-year, led by a 6% jump in single-family homes amid flat condo sales. More importantly, however, is that the country finished the month with just 6.3 months of available inventory, in line with recent months and one of the lowest readings since early 2006. While this low level of available homes for sale is likely also crimping existing home sales, we're encouraged that the national median existing home price climbed 2.5% year over year. We think these increasing prices can help spur renewed interest in homebuying, potentially bringing additional life to this long-beaten-down industry.

New housing starts in the United States declined on a seasonally adjusted basis, but favorable weather spurred strong quarterly growth. The annualized, seasonally adjusted level of housing starts showed a 5.8% slide from prior-month levels in March, but climbed 10.3% year over year in the month. For the quarter, total nonadjusted housing starts jumped more than 19% compared with 2011's first quarter. As we've previously discussed, favorable weather conditions in the United States likely spurred a good deal of this activity, but we're mildly encouraged that homebuilder sentiment--though down to 25 in April from 28 in March--is still well ahead of year-ago levels. Although housing starts remain well below levels prior to the Great Recession, barring another economic shock we believe this industry may have finally begun to turn the corner.

There's More to the Housing Crisis Than Pricing and Foreclosures
While everyone continues to focus on foreclosures and pricing, I suspect there are a lot of other issues that may be even more important. My current big worry is young adults and both their attitudes and capabilities concerning home purchases. Those from roughly age 22 (college graduation age) to late 20s/early 30s (when most decide to have a family) have what we at Morningstar call a lot of optionality. They can live at home, rent an apartment, or purchase a home or condo.

For many years, this age group stayed at home, or more likely, shared an apartment with friends until they could save up enough money for a down payment. However, in the late 1990s and early 2000s this group rushed to buy housing, so as not to be permanently locked out of the housing market because of rapidly escalating prices. This served to artificially boost both demand and prices.

Now, the cohort of twentysomethings is scared to death to own a home. Worse, a weak employment market has hit recent high school and college grads hard. This age group suffers substantially higher unemployment rates than the general population. Sky-high student loan levels aren't helping matters for this age group, either. A recent Wall Street Journal article pointed out that recent grads are putting off marriage and delaying children because of massive student debts. Once this age group reaches 30 or so, the options will become fewer, and more of these individuals will purchase (or perhaps rent) single-family homes (for space issues and the need to be near high-quality schools). They represent long-term demand deferred, not eliminated.

Dating the housing crisis from 2008 (although there were clearly some visible cracks as early as 2005), it might be a couple of more years before this group makes a decent contribution to the housing market. But better employment prospects, rising rents, and changed attitudes could accelerate their participation some.

Once we get over that hump, if we return to more normal household formation rates, the economy will need about 1.5 million new homes per year (versus the 700,000 or so rate that we are at now or the 2.2 million units we reached at the artificially induced top), based on population trends that we can already see. In my mind it remains a question of when, not if, we will see a better market for homes, both new and used. I still expect that higher rents, parents who love their kids but could do without the late nights and occasional messes that boomerang children bring with them, and better employment are likely to bring at least some improvement in 2012. 

Can the Housing Market Turn as Sharply as the Auto Industry?
Just a year ago (when the average selling rate was well under 12 million autos), no one, and I mean not one person, thought we could sell 14.5 million cars for any month in 2012. Now we have managed to sell more than 14 million cars in each of the first three months of 2012, and even hit a 15-million-plus rate in February. Cars do wear out at a substantially faster rate than homes, but it is still interesting to watch how this industry that was given up for dead turned on a dime.

Retail Sales Did Better Than I Expected
Last week I mused that because of a lack of competing news, the market would be highly sensitive to the government's retail sales report. I had worried that the market would react badly to a March growth number that would look paltry compared with a strong February. Instead we got a March retail sales level that was barely down from an impressive February (0.8% for March, 1.0% for February). Even excluding autos and gasoline, the numbers were still impressive. On a year-over-year basis, the numbers were very much in line with the slow but steady growth pattern of the last year:

I find it truly amazing that these numbers have been so stable. The all-in monthly data basically looks like a random number generator. Over the same 13-month period, the monthly data ranged from 0% to 1.0%, which annualized to 0.0% to 12% (at least the midpoint of the monthly data is about equal to the 5.9% rate that the year-over-year data showed). So despite what some commentators might have you believe, consumers have been remarkably even-keeled over the past year despite a broad array of supposed disasters. On the other hand, despite better employment data, consumers have not busted out the champagne just yet. Retail spending remains stuck in a slow but steady pace, frustrating both the economic bulls and bears with neither able to gain a definitive advantage.

I do look at the monthly data to see what's hot and what's not by category. The news here is outstanding with almost every category reporting month-to-month gains with only drug and personal care stores showing a month-to-month decline. Groups growing 1% or more included building materials (probably helped by an early spring), gasoline, furniture, and electronics (I think the new iPad may have moved the proverbial needle). Furthermore, autos and clothing each managed to kick in a 0.9% increase, even in the face of some recent price increases.

The strong results seemed to indicate that consumers are taking the recent price increases for gasoline in stride, despite some dire predictions to the contrary. I think a lot of people associate last spring's slowdown (the year-over-year retail sales growth reached its nadir in April 2011) with rising gasoline prices. However, a lot of other prices, including food and automobiles, were also moving up rapidly. Currently, overall inflation is trending down, versus a year ago when inflation was really beginning to heat up. Remember, gasoline represents less than 5% of the consumer price index.

A Decent GDP Report for the First Quarter Due Next Friday
Given the strong bump in monthly retail sales, economists are in the process of revising GDP growth forecasts for the first quarter one more time. Though the formal consensus is now 2.3%, most of the reports I read these days seem to suggest estimates of 2.5%-3.0%. That won't prove to be very far behind the fourth quarter's 3.0% rate. And the "quality" of the first-quarter report will be viewed as substantially higher because consumption is likely to move up from 2.1% to a range of 2.3% to 2.5%. Meanwhile, inventories are likely to represent a smaller portion of GDP growth.

Fed Open Market Policy Statement Due
I haven't focused on Fed statements all that much in the past. However, the market has focused on them like a laser beam, generally pleased when there are hints of further easing and disappointed when the Fed is feeling more optimistic about the economy. My guess is that the Fed will continue to pledge to keep the economy moving forward, whatever it takes. This week's economic news (and frankly, a lot of data released in April) has been relatively uninspiring and will probably keep the Fed's inflation hawks at bay for Wednesday's release.

The Two Major Home Price Indexes to Be Released Tuesday
Both the Case Shiller and the less volatile Federal Housing Finance Administration (FHFA) price indexes will be released on Tuesday. The FHFA report is based on a single month and has generally been trending up. Case Shiller is a three-month average and has still been showing negative readings. Given a better housing market and the improved FHFA numbers, I am going out on a limb to predict that we will get a monthly, sequential improvement in the Case Shiller index, which just might lift both housing and stock markets' spirits. Frankly, just the absence of headlines saying that we made a "new recovery low" would make me a happy man. I am also expecting a positive result from the FHFA report based on better median prices that showed up in this month's existing home sales report.