The state of the economy

Below you'll find commentary on the state of the economy from Dr. Scott Brown. An economist who I have followed for a number of years now because of his accurate calls.

"The economic data have remained mixed in recent weeks – and if you like this trend, you’ll probably be pleased as the figures roll in, still varied, in early 2007. The data suggest moderate growth overall, but there’s no sign that the economy is spiraling down. In fact, much of the weakness in housing and autos is likely to be transitory. The recent softening in growth does leave the economy susceptible to negative shocks, but for the most part, the outlook for 2007 is promising (although not outstanding). The Fed should remain on hold.
The retail sales figures for November were stronger than expected, but the data have been subject to some distortions in the last few months. Specifically, gasoline prices (down sharply in September and October, firming somewhat in November) have whipped gasoline service station sales around. Sales of autos and building materials also tend to be choppy. Ex-motor vehicles, building materials, and gasoline, the underlying trend in retail sales appears to be moderately strong.

The early reports on the holiday shopping season have been mixed, but generally moderate – although a little disappointing. Mild temperatures have been a drag on apparel sales, but while consumer traffic is up, spending is relatively cautious. However, retailers still expect a late surge ahead of Christmas. In addition, the trend toward gift cards appears to be growing. A fair portion of sales that would have previously occurred in December appear to be shifting to January. Consumers are conditioned to expect heavy discounting ahead of December 25 and generous promotions after (ironically, retailers ship in plenty of new merchandise for these “clearance” sales). January and February, which have always been considered “transition months,” are being supported more and more by gift card redemptions.There was some encouraging news on the housing front. Mortgage purchase applications were down about 3% from a year ago (vs. -20% y/y in August and Sept.).

Mild weather may have played a part in the relative firming of mortgage purchase applications. Low mortgage rates, rising incomes, and declining prices (in some areas) may also be factors. One shouldn’t put too much weight on any one week’s worth of data, but at face value the figures do support the view that the worst part of the housing decline is behind us (although, admittedly, there is likely more downside to go).

Industrial production edged up in November, in line with the consensus forecast. However, the figure was boosted by a rebound in auto output. The increase in auto production appears to be a statistical fluke (the seasonally adjusted data are choppy) – it certainly was counter to the anecdotal evidence. Production of technology goods remains moderate (aided by adjustments for faster processor speeds). Ex-tech and autos, factory output remained lackluster, consistent with related weakness from autos and housing, but also likely reflecting a moderate inventory correction.

For manufacturing, the key question is whether the weakness is transitory or the beginnings of a broader downturn. Corporate profits and cash flows, which are strong drivers of capital spending, have remained brisk, but firms have been generally more cautious in their outlooks. The household sector will face some drags from the housing weakness, but continued job growth, combined with improvement in inflation-adjusted wages, should provide important support to consumer spending growth into 2007. The auto and housing slowdowns are likely to prove to be transitory (a move to a lower level of activity) – and as long as there isn’t appreciable contamination to other sectors (so far, so good), the economy should remain in good shape in 2007.

November’s benign core CPI reading is unlikely to push the Fed to lower short-term interest rates anytime soon. Some of the softness was due to special factors (prescription drugs, autos, etc.). The main factor driving Fed policy in 2007 is likely to be job growth – and job growth is likely to remain moderately strong."