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March 16, 2006

Labor Market Helps Economy Expand
by Chad Hudson

Last week, the Labor Department reported that 244,000 new jobs were created in February. This was a little more than the 210,000 economists predicted, but negative revisions totaling 18,000 to the previous two months muted the strength of the report. In each of the past two months, the most jobs were added in the construction industry. Average hourly earnings increased 0.3% during February and were 3.5% higher than a year ago. This is the largest year-over-year increase since September 2001 and is further evidence of inflationary pressures building in the economy. For anyone looking for negative news, the duration of unemployment rose from 8.4 weeks in January to 8.9 weeks, but is down from 9.2 weeks last year.

The recent employment survey conducted by Manpower shows that employers plan to add workers in the second quarter. The seasonally adjusted net employment index rose one percent to 21%. Employers in the West have the strongest employment plans with an index reading of 26%. The mining and construction industries plan to add workers more than the other industries. Public administration is the lowest. Internationally, employers in the Asian countries have the highest hiring plans.

Retail sales declined 1.3% in February after the Commerce Department revised January sales to a gain of 2.9% compared to earlier estimates of 2.3%. The 2.9% monthly gain last month was the highest monthly gain since at least 1992, excluding the bounce that occurred in October 2001. Most of the weakness was in auto sales. Excluding vehicle sales, retail sales dropped 0.4%. This was slightly stronger than estimates, -0.5%. Compared to last year, retail sales have maintained an impressive pace. Total retail sales were up 6.5% last month and increased 8.8% excluding auto sales. Several specialty apparel retailers reported disappointing February sales. The retail data from the Commerce Department confirmed the weakness. Year-over-year sales at clothing stores increased only 0.9%. This was the weakest growth since a decline in March 2003. Retail sales have remained buoyant during the first two weeks of March. Sales were up 4.3% during the first week of the month compared to last year, which was the strongest gain in weekly sales since the week of Thanksgiving. The latest week, sales dropped to 3.7%.

The Empire Manufacturing survey from the New York Federal Reserve offers the first look at health of the manufacturing sector each month. According to the survey, the manufacturing sector has started to accelerate. The headline number soared 10.2 points to 31.2. This was the highest reading since July 2004. Prices paid dropped 13.1 to 40.2, lowest since August 2005. Additionally, prices received dropped 8.7 points to 12.82, lowest since September 2005. The employees' component jumped 15.8 points to 21.75, highest since May 2004. Plus the workweek increased 19.8 points to 25.3, the highest since the index was created in 2001. Expectations are not as rosy. Expectations for orders and shipments fell to the lowest level since March 2003. While the index tracking capital expenditure plans fell 3.5 points, it remained the third highest level since it was started.

The Federal Reserve published the latest Beige Book on Wednesday. The report echoed the economic data that has been reported and didn't contain any surprises. The survey reported that economic activity continued to expand at a "moderate or steady" pace. While consumer spending continued to expand, "household lending softened." This is mostly due to slower activity in residential construction. While the residential market continued to slow, the "commercial construction markets were generally more active than at the end of 2005." Business spending continued to increase for both capital expenditures and business services. Labor markets remain tight, with most districts reporting that businesses continued to add to payrolls throughout most of the country. Cleveland and Kansas City were two exceptions. While companies have added workers, there has been a problem finding skilled workers. According to the survey, "Almost every district reported shortages of high-skilled workers." Input prices continued so rise, but "prices at the retail level increased at only a moderate rate." The report noted that, "The costs of many non-petroleum materials - including asphalt, cement, gypsum, lumber, copper, and paper - were on the rise."

Sears Holdings beat estimates on cost cutting. Gross margin increased from 27% to 28.3%, while SG&A was slashed from 20% of revenue to 19.1%. Kmart same store sales increased 0.9% during the fourth quarter due to increased sales of apparel and home products. It was the first increased in four years, but sales at Sears dropped 12%. The drop was due to the focus on improving gross margins by reducing the number of promotional events. Additionally, the company said that it experienced weaker than expected sales of fashion apparel.

Companies are starting to issue earnings pre-announcements for the current quarter. This week Union Pacific and DuPont said earnings would be higher than current estimates. Union Pacific said the better results were "driven by strong demand for Intermodal, Industrial Products and Agricultural Products." Additionally, it said "first quarter 2006 carload volume is expected to increase 4 percent versus an original outlook of 3 percent growth." DuPont raised its guidance on first quarter earnings by a dime to $0.80 per share. It said while several of its businesses have improved, it has been offset by "weaker market conditions in Europe and unfavorable currency trends."

Early this week the bond market got a reprieve from the research firm Medley Global Advisors. The research firm said the Fed will stop raising rates after one or two more increases. This caused a sharp rally across the yield curve. Fed funds futures trades also pared back the expectations that the Fed will continue past 5.0% this year. The case can be made that the Fed pauses at 5.0%, but unless the economic data starts to deteriorate, it's likely that the target rate will be higher than 5.0% at the end of the year. A strengthening labor market will likely keep the consumer confident and spending even as housing slows. Higher rates will be detrimental to the consumer and the economy, but by the Fed taking its time, everyone is able to adjust to higher rates. We have already seen an increase in 40-year fixed rate mortgages. It will take quite a bit to knockout the consumer, but once it starts it will likely accelerate at a rapid pace.

Chad Hudson
Mid-Week Analysis
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