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June 02, 2005

The Economy Needs Extra Innings
by Chad Hudson

First quarter GDP growth was revised up to 3.5% from the preliminary estimate of 3.1%, and slightly below the consensus forecast of 3.6%. The narrowing trade deficit and higher consumer spending were the main contributors to the upward revision. The trade deficit reduced GDP growth by 0.7%, less than half of the 1.5% reduction from the preliminary calculation.

Personal Income rose 0.7% in April and 7.0% from last year, matching the four-year high (excluding December 2004, which was boosted by Microsoft's special dividend) set last month. Personal Spending increased 0.6% in April from the prior month, and was 6.9% above last April's levels. Due to higher taxes, disposal income increased 0.5%, pushing the savings rate to 0.4%. Excluding October 2001, this was the lowest savings rate ever. With interest rates heading north, interest payments increased. In March of 2004, interest payments amounted to $178.1 billion. This has grown to $212.0 billion, just $3.7 billion shy of the high set in July 2001. Inflation is starting to reach consumers. The PCE deflator rose 2.7% from last year, up from 2.4% in March. Only in March 2000, did the deflator have a larger year-over-year increase over the past twelve years.

The two leading surveys of consumer confidence diverged in May. The University of Michigan consumer confidence was revised upward 1.6 points to 86.9 from the preliminary report, but still below April's reading of 87.7 The weakness was in the expectations portion of the survey. The survey conducted by the Conference Board rose 4.7 points to 102.2. The current situation rose 2.9 points to 116.7, which is 0.3 points away from the highest level since September 2001. Expectations increased 5.8 points, to 92.5, which reversed a four-month decline. Those that viewed jobs as plentiful rose 2.2 points to 22.6, the highest since September 2001. There was a surge in plans to purchase an automobile, as 7.6% of respondents anticipate purchasing an auto within the next six months, up from 5.8% last month.

The pace of auto sales slipped in May to 16.7 million units, 8% below last year. As has been the case for the past several months, the Japanese automakers grabbed market share from the domestic manufactures. General Motor's sales dropped 13%, while Ford's sales fell 11%. Chrysler's sales were better than its domestic counterparts, but still declined 2.5%. Of the large automakers, Nissan posted the best results. Its sales increased 6.6%. Toyota sales were flat and Honda had a 15% decline. GM is going on the offensive again, offering higher incentives. It will offer its employee discount to everyone.

The Chicago PMI dropped 11.5 points to 54.1 in May. This was the steepest drop since September 1974 and the lowest level since June 2003. While every component fell, only inventories showed expansion. This is similar to the results of the national ISM survey. The ISM manufacturing survey dropped 1.9 points to 51.4. This was the sixth consecutive drop and is at the lowest level since June 2003. The only component that increased was customer inventories. Employment fell 3.5 points to 48.8; this was the first time employment showed contraction since October 2003. Prices fell 13 points to 58. While this still signals that prices are increasing, it is at a much slower pace. Commodity prices starting rising rapidly last year and have leveled off this year. While manufacturers are starting to seeing prices stabilize, unless prices start declining it is likely that manufacturers will continue to attempt to increase prices.

Most retailers will report May same store sales on Thursday. The ICSC forecasts that May same store sales rose 3.0%-3.5%, which is consistent with the 3.0% to 3.7% same store sales gains reported in its weekly reports during the month of May. Weather is being cited as a reason for lackluster sales. According the SDI/Weather Trends, last month was the coldest May in at least twelve years.

Kohl's announced its results early in order to facilitate an analyst conference. Its same store sales increased 0.2% with total sales growing 10.2%. Analysts expected sales to increase by 0.8%. The company said it remains more confident for the second quarter, forecasting sales to increase 4%-5%. Wal-Mart announced that its same store sales rose about 2.5% in May, toward the lower end of its 2%-4% forecast.

Higher end retailers have done better than those catering to lower income customers. This trend has continued during the first part of the year. Neiman Marcus reported that its third quarter earnings jumped 16% to $1.61 per share, about a nickel above analysts estimates. Same store sales advanced 10.2% with catalog and internet sales growing 14.1%.

Hovnanian Enterprises reported earnings that were a penny better than estimates. Homebuilding revenue increased 32% to $1.19 billion, driven by a 12% increase in deliveries and an 18% increase in average selling price. Its average selling price is now $317,400. Investors were concerned about the 2% drop in new orders due to weakness in the West and Northeast. Because of the higher prices, new orders on a dollar basis increased 10% and backlog increased 13% in units and 32% in dollars. Last week, Toll Brothers announced that it earned $2.01 per share during the quarter that ended April 30. This was twenty-two cents higher than estimates and more than twice what the luxury homebuilder earned last year. Homebuilding revenue increased by 52%, with closing up 31% and price up 15%.

After experiencing rapid growth over the past two years the manufacturing sector has started to slow. Consumer spending has remained robust, and the housing market is overheating. Similar to other times that it appeared that economic growth slowed, interest rates have declined. This will only exacerbate the housing market. On Wednesday, Richard Fisher, the new President of the Federal Reserve Bank of Dallas, said that the Federal Reserve is "clearly in the eighth inning of a tightening cycle." The Fed needs to reclaim control of interest rates and not allow hedge funds and other speculators to dictate interest rates. If interest rates remain at current levels, the housing market will only become more damaging when it ends.

Chad Hudson
Mid-Week Analysis
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