Steady as She Goes

Other than a poor reaction to the nearly useless consumer confidence numbers on Friday, the market seemed to like the economic figures it saw this week. Month-to-month retail sales data that everyone has been intently waiting for increased 1.1% month to month, formally allaying fears of payroll tax increases curbing consumer shopping habits. Those fears were fed by earlier rumors that  Wal-Mart (WMT) had a "disastrous" start to February.

Another surprising drop in initial unemployment claims, now at their lowest level in five years, also helped move the markets along. Continuing on the employment front, the Job Openings report showed an increase in openings and an increase in people quitting--a sign of optimism. This bodes well for labor markets, perhaps indicating that last week's strong monthly employment report was not a one-time fluke.

Industrial production also was surprisingly strong on a month-to-month basis, increasing 0.7%, after an originally announced decline in the previous month. The government even managed to chip in with a smaller than anticipated budget deficit for February, with increased revenue and expenditures barely below prior levels.

High inflation news was the only real fly in the ointment this week, but a bad report was widely anticipated. The number-one culprit in the inflation-poor report was energy prices (three quarters of the stunning 0.7% increase). The gasoline portion of the index is already well on its way to completely reversing itself in March, especially on a seasonally adjusted basis.

Economists Racing to Increase First-Quarter Growth Estimates
All the good news had economists scrambling to raise their first-quarter GDP estimates that are now generally in the 2.0%-2.5% range, despite the payroll tax increase, gasoline price rises, and seemingly endless government-manufactured crises. Fragile economy, hah!

On the other hand, reports of the economy approaching escape velocity are also resurfacing. While I am optimistic, I am not buying that, either. As good as all this week's numbers looked, they were an awful lot less exciting when viewed on a year-over-year averaged basis. Looked at through that lens, the data showed more of a slow, steady, sustainable growth rate. That should prove more satisfying than the quick spurt that many people are now beginning to anticipate.

Economy Is Not Nearly as Volatile as Monthly Data Suggests
The month-to-month volatility and spurts and drops that so many economists speak of are mirages, in my opinion. Looked at on a year-over-year basis, the recent data, including employment, production, and retail sales, have been shockingly stable. All of the month-to-month volatility that many are conjuring up is a reflection of monthly data proven nearly impossible to seasonally adjust--especially when the underlying growth rates are so small compared with the necessary seasonal adjustments. (Not to mention weather events that are wreaking havoc with so many monthly statistics.)

Consumers Not Dead After All: Retail Sales Jump 1.1%
The government's retail sales report provided welcome relief to investors who were worried about the consumer headwinds from gas prices, payroll tax increases, and income tax refund delays. The report showed that total retail sales jumped 1.1% from January to February following a measly 0.2% gain in January, led by jumps in autos and gasoline. However, even excluding those two big movers, sales were up 0.4% (4.8% annualized). Excited as everyone was about the number, I wouldn't get too riled up. The year-over-year gains were little changed from recent trends, as shown below:

Inflation-Adjusted Sales Trend is Slightly Positive
The trend is slightly better if we inflation-adjust the numbers. After some weakness this fall, the inflation-adjusted sales figures have been ever so slowly improving since October. So while some commentators are calling this a break-out month, the hard data clearly shows that we are really just getting more of the same slow and relatively steady growth. Also keep in mind that unusually warm weather, which caused spring buying to happen early in February and March, drove some of the early strength in 2012.

Restaurants Take the Worst of the Hit From Increased Payroll Taxes
Some of the individual category data on a month-to-month basis revealed some of the winners and losers from the recent payroll tax increase. Restaurants were among the really big losers, as shown below:

Sporting goods had been showing an exceptionally strong growth and this month's fall is a return to more normal conditions. Furniture was also doing pretty well, but is probably hurting more than most from slow tax refunds. On the plus side, high gasoline prices were good news for non-store retailers (think  Amazon (AMZN)) as was more stormy weather. Building materials are clearly benefiting from a general rebound in housing activity.

Trend Data Shows a Shift Away From Brick-and-Mortar Sales
As interesting as these monthly numbers are, it was a little disconcerting to find how much the numbers for one month earlier changed. (When I cut-and-pasted this month's report, including last month's revisions, I was shocked by how much the January data changed, including some gains that were now losses.) That caused me to look at the category data in a new way. To get the longer-term trend, I compared recent data with year-ago data. Then I looked at the most recent three months and compared them with three months immediately prior and annualized that result for comparability. A three-month sequential number above the year-over-year number indicates an improving trend.

I discuss some of the major trend changes in this week's video. For now I would highlight that Amazon and other retailers continue to take major share away from brick-and-mortar stores. High gas prices, no sales taxes in many states, and poor weather all converted more shoppers to online channels. That is why both the department store and general merchandise categories look so abysmal. An increase in household formations is helping both autos and housing-related categories (furniture and building materials). Looking at the aggregates, the retail market is little changed from its trend, no matter which way one cuts the numbers.

Weekly Shopping Center Data Soft but Stabilizing
The weekly shopping center data continues to show slightly more weakness, as many of the stronger categories (autos, furniture, non-store retailers) are not typically included in the report. The good news is the weekly numbers are definitely stabilizing and are about to get a boost from an earlier than usual Easter.

The five-week moving average of sales remains above 2%, but not by much. No particular worries with the weekly data, but those declaring a new boom in consumer spending are a bit premature, based on these weekly reports.

Recovery Killer Inflation Remains Under Firm Control When Looked at Properly
Overheated headline writers are having a breathless day at the desk. This MarketWatch one typified some of the hype:

INFLATION HIGHEST IN MORE THAN THREE YEARS

What the headline fails to note is that year-over-year inflation is a meager 2% and when averaged over three months is still at 1.8%. These are "all in" figures; I am not excluding anything, including the 9.4% one-month increase in gasoline. For the record, the one-month inflation did indeed jump 0.7% between January and February, just ahead of consensus estimates, with three quarters of that increase due to a spike in energy prices, some of which has already been reversed.

Year-Over-Year Inflation Remains Under 2%
Averaged, year-over-year inflation has been (and remains) under 2% since June. And gasoline and energy products were really the only big upside movers. None of the large categories except used cars (which had been falling like a rock) and energy were up more than 0.3%. In fact, the table below also shows a number of categories were actually down. After a run of high numbers last fall, even food prices are under solid control, gaining just 0.1% in February after showing no gain at all in January.

Next month's inflation data should look even better both month to month and year over year solely because gas prices have been down for March so far. Government statisticians assume gas prices normally rise almost 7% in March. Combining the 2% decline at the pump that we have seen so far in March with that downward 7% seasonal adjustment, the "CPI reported" gasoline price could drop by almost the same 9% factor that it grew by in February. Let's hope I am not counting the chickens before they are completely hatched. I admit my first check every morning is the AAA Gas Gauge website.

Production Data Looks up Month to Month, Continued Erosion Year Over Year
Unfortunately the headline data for the manufacturing portion of industrial production (I exclude mining and utilities, which often reflect weather issues and not real demand) looks a little stronger than reality. My long-term view is that production continues to slow after a big post-recession and is now approaching longer-term, sustainable averages. That's not bad news, but it means that it is less likely that manufacturing is going to be a major engine of growth:

That said, February's year-over-year growth rate is still a respectable 2.9% compared with the 40-year average of 2.6%. A large decline in autos in January followed by a big bounce in February drove the strong month-to-month increase. Given that auto sales were basically unchanged between those two months, the volatility in production is a little puzzling.

Looking forward, the purchasing managers' survey has shown four consecutive months of healthy increase and remains well above 50 (with a strong new order component to boot). This would seem to indicate that at a minimum, manufacturing is unlikely to be a drag on the economy as many had feared. I note there is still a tiny bit of runway room in front of us in the manufacturing sector, as it's still running almost 4% below its all-time high reached in 2008.

Next Week Is Real Estate Week, Along With Some World Manufacturing Data
As is typical for the third week of the month, builder sentiment, housing starts, and existing home sales are all due next week. For added measure, the FHFA Home Price Index is expected on Thursday.

The home builders index is expected to remain basically flat at 47 as it has been for a couple of months after rocketing up for most of 2012.  Lack of available property for sale and rising construction costs certainly aren't helping sentiment in the short run. 

Housing starts are expected to pop back over 900,000 for February to 915,000 after falling back below that level in January as apartment buildings took a bit of a pause. It is important to analyze the apartment buildings separately from single family construction. Also remember the weather has not been as conducive to home building, especially in the Midwest, compared with a year ago. 

Existing home sales are expected to increase from 4.9 million units to 5.0 million units based on increased pending home sales in earlier months. However, exceptionally low inventories may limit sales. Inventories, which have been dwindling for some time, should increase over the next several months as we have now entered the post-Super Bowl spring selling season. Let's see if the new higher prices finally draw a few new sellers.

The Markit versions of worldwide purchasing managers' reports are due next week.  Eyes will be strongly focused on the China numbers, which made a surprisingly large decline in February. There had been a strong feeling that the timing of the lunar holidays might have influenced some of the earlier data in both directions. I don't necessarily view these numbers as terribly important, but they have been real market movers the last couple of times they have been announced.

Speaking of market movers, the Fed also meets week. Although I am not expecting any significant changes in policy, the market will continue to parse each and every word of the final briefing due on Wednesday.

Note: This article has been corrected since original publication. First, we corrected an error about the government's assumptions for March gasoline prices. Government statisticians assume gas prices normally rise almost 7% in March, meaning they make a downward seasonal adjustment of 7%. The original text had erroneously stated that government statisticians assume gas prices normally fall almost 7% in March. 

Second, we added information about the coming week's housing reports into the last section of the article, titled "Next Week Is Real Estate Week, Along With Some World Manufacturing Data." The information had been inadvertently clipped off the article upon original publication.