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December 30, 2005

Out Like a Lion
by Chad Hudson

Everyone's attention has been on the holiday shopping season and consumer spending. After weeks of worrying it appears consumers were able to increase spending. While everyone has different methods of calculating sales, most conclude that it was a good season, but not great holiday season. According to MasterCard's tally, sales increased 8.7%, led by home furnishings and electronics. ShopperTrak RCT also reported that consumer electronic retailers had very good results while sales at department stores lagged. Chain store sales increased 3.9% during the week leading up to Christmas according to the ICSC. Mike Niemira, chief economist for the retail trade group, said that sales were pushed out later into the shopping season, partly due to a later Hanukkah and one extra Saturday before Christmas. The growing reliance on gift cards also pushes sales to after Christmas. It still expects total holiday sales to be up 3.0% to 3.5% from last year and graded the season a "C plus." This would be the second largest increase in holiday spending since 1999. Sales were up 4.0% in 2003. There was a lot of discussion from analysts about the holiday season being very promotional. This usually causes margins to compress, but that might not be the case this year. When retailers reported third quarter earnings, several mentioned that their initial markups were higher than in the past. With higher markups, retailers would have more leeway for promotions without damaging the bottom line.

Consumer confidence rose 5.3 points to 103.6 in December. This is back to the levels before the hurricanes struck the Gulf Coast. Interestingly, even though the headline index along with most components have rebounded back to August levels, the number that thought business conditions were good barely recovered, up only one point from the low to 24.3%. It was 29.7% in August. This was offset by the number of people that thought business conditions were bad. Those that thought business conditions were bad dropped to 14.7%, the lowest level since July 2001. Perhaps one indication that higher gasoline prices have altered consumer behavior is that fewer consumers intend to travel by car to their next vacation destination. Only 20.6% of consumers plan on taking a vacation via automobile. This is the lowest percentage in at least two years, which as averaged around 23.0%.

While consumers have gotten more optimistic, home builders have lost confidence over the past two months. In November, optimism among the nation's home builders dropped to the lowest level since April 2003. The survey from the National Association of Home Builders dropped four points to 57. The drop was due declines in present sales and prospective buyers' traffic. The index tracking traffic of potential buyers dropped eight points to 39. This was the lowest level since October 2001. Additionally, the index for present sales dropped four points to 63, which is the lowest since April 2003. Even though these indexes have dropped over the past couple months, it should be remembered that these are diffusion indexes. Levels above 50 indicate that business expanded. David Seiders, chief economist for the National Association of Home Builders, said that, "three out of four homebuilders are experiencing some buyer resistance to current home prices, and many are offering certain concessions to buyers in order to help maintain sales volume."

Housing starts increased 5.3% in October, to an annualized rate of 2.123 million homes. This is only off 5% from the record pace set in February. Building permits increased 2.4% and are only 3% from the record set in September. At this point, the talk about the bubble popping seems premature. Only the South reported a decline in housing starts and the West set a new record on number of starts. The total number of single family units under construction rose 2.1% to a new record. To add prospective, during the mid-1990s there were between 540,000 and 600,000 single family units under construction each month. This grew to between 650,000 and 700,000 during the late 1990s and early 2000s. In October there were 977,000 homes under construction. This provides a significant contribution to economic growth.

New home sales dropped 11.3% to 1.245 million homes. This was a larger decline than economists expected following a surge in October. Additionally, the number of new homes for sale increased 3.2% to a record 503,000. The decline in volume coupled with high inventory caused the months supply ration to surge to 4.9 months from 4.2 last month. This is the highest it has been since December 1996. As of the end of November, there were 1.202 million new homes purchases, just 1,000 shy of the record set in 2004.

Producer prices dropped 0.7% in November, after rising 0.7% in October. This was the largest monthly decline since April 2003 and was driven by a decrease in energy prices. Gasoline prices dropped 10.7% in November. Excluding energy, prices rose 0.3%. Compared to a year ago, producer prices increased 4.4%. While inflationary pressures appear to have moderated from the high levels caused by the Gulf Coast hurricanes, it is likely that prices will continue to trend higher as manufacturers pass along price increases.

2006 should prove to be very interesting. Investors will come into the year with wide ranging views on just about every important aspect of the economy. Perhaps the most agreed forecasts calls for the economy to slow next year, but to what degree is debated. It is also certain that the Fed will stop raising rate this year, but when? Most Fed watchers expect the Fed to stop at 4.5% or 4.75%. This will depend on how strong the economy remains and if inflation is contained. The housing market has been one of the largest drivers of the economy. If the housing market fails to slow in response to higher short-term rates, the Federal Reserve will face a difficult dilemma. The asset inflation of the late 1990's is still fresh in the minds of the Federal Reserve and a similar result would carry much larger consequences.

Chad Hudson
Mid-Week Analysis
PrudentBear.com

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