By Jeff Bailey
It's summer time in the northern hemisphere and kids are looking
forward to some time off from school, but this week's e-mail was
largely comprised of questions centering around inflation, and
various economic indicators.
While I'm not an economists, my business marketing/finance degree
in college required me to sit in many a class and listen to the
professor spew out tons of information and theory on economic
indicators and how a student studying business should have a firm
grasp of various economic indicators.
One thing I learned, which didn't become a core belief until
after I got out in the "real world," was that you can give 5
economists or analysts the same set of data, and the odds are
that you would get back 5 very different answers as to what the
economic data was saying.
Gone now are some of the concerns for deflation that usually come
from an economic recession, and sure enough, its inflation that
is on everyone's mind as the U.S. and global economy improves.
Is there one single economic indicator that is MOST important to
follow, or understand?
My answer, would be emphatically... NO!
That's why we get hammered with so many economic reports each
week. And with these reports can come confusion, and sometimes a
"rush to judgment" as to what that economic report may have
Based on some of the questions received this week, I thought I'd
pick out a few economic reports that are released each month,
place them in a table where we could look at some of the data,
and try to understand, or get a feel, for how the various
economic reports all mesh together, where somehow, the various
markets we may be trying to trade/invest in, always seem to get
it right, as they correctly predict the eventual outcome of what
the economic data was saying.
Certainly there are times when the MARKET suddenly realizes it
was wrong in its original analysis, and when it does (the MARKET
that is), it is quick to adjust and make appropriate corrections.
I went through a very long list of various economic reports we
are hammered with each month, and tried to pick out some of those
that I feel can be of focus at this point in time.
During the recent recession, it was the housing market that was
of great focus as the industrial and service portions of the
economy were in decline, where construction of homes was one of
the key drivers for keeping some pulse in the economy. While the
homebuilding market will always be a key part of the U.S.
economy, we won't be discussing those economic data in this
Certainly I will have left out something that you deem overly
necessary to have considered, but by the time most of us get the
crash course in Econ. 101, we will have had enough from some of
One of the most often-asked questions after an economic report
has been released is "why did the market do this, and not that?"
Like I said.... give 5 economists the same set of data, and
you'll probably get 5 different analysis of that data.
Hopefully I can try and walk through some of the things I've
learned not only in college, but in life and from other business
people, are how to at least think about various economic
readings/reports, to try and build a foundation of just what the
MARKET is thinking, and where we can look for clues for further
confirmation of our economic analysis.
You may want to print the following table out in order to follow
along with today's discussion.
Table of Economic Reports - Dec. 2003 to May 2004
Good gravy! This is the reduced version? Don't worry, I'm not
going to go into great detail on every single number, but I
wanted to at least give us 5-months of various economic report
observations, so we can get a feel for what some of the economic
reports have been.
At the top is quarterly Gross Domestic Product (GDP), where in
the fourth quarter of 2003, the economy grew at a 4.1% annual
rate. Recent economic data showed the economy grew at a 4.2%
annual rate, where on May 27, we're going to get a potentially
revised reading on the first quarter's GDP, which economists are
currently forecasting an upward revision to 4.5%.
If you don't understand what Business Inventories are, or any of
the other economic reports about to be discussed in brief, most
of them are described in the EDUCATION section of the website
Business Inventories and Sales: has been one of the most dynamic
and sometimes misinterpreted (in my opinion) pieces of economic
data. One of the biggest "rush to judgment" analyses is when the
Business Inventory headline number is considered by itself,
without any regard as to sales trends. One thing I learned from
a client of mine (he managed a manufacturing plant in Puerto Rico
for Hewlett Packard) was how a efficient corporations were
becoming in the management of inventory (especially at the
wholesale end of inventory). I was shocked to learn that that
his plant actually overnight couriered in slats of
microprocessors just ahead of a large production run. I told him
that that was way too expensive, but he explained that holding
INVENTORY of those processors (more storage space and that's
costly, buy those processors months in advance and that's dead
money sitting in storage until product is manufactured and then
sold, an earthquake or geopolitical event could become costly for
inventory held, etc.) Perhaps you've heard the term "just in
time" inventory, where the concept is that your inventory shows
up just in time to get it into production, and not let it sit
around. Just in time inventory plays a BIG ROLE in why inventory
to sales continues to decline.
An just what is "just in time" inventory a part of?
That's right! PRODUCTIVITY which helps LOWER the COST of
manufacturing goods. Fed Chairman Alan Greenspan and other Fed
governors are constantly talking about the rates of productivity
as being a key part of their inflation/deflation analysis.
Wholesale Inventories: are the second stage of the manufacturing
process, and perhaps more difficult for a business unit to
handle, but can give important readings on demand for the
Business Inventories, or first stage of a products manufacture.
Certainly demand (sales) has been outstripping supply
(inventory). Is this inflationary? Or is this dynamic partially
created from PRODUCTIVITY?
Factory Orders: Once you've gotten information from Wholesale
Inventories, the Factory Orders usually doesn't carry that much
weight, but can still be an important demand observation, which
helps separate out lower priced ticket items we call non-durable
goods. This economic indicator can give us a QUANTITATIVE
reading on consumer spending, where Consumer Sentiment readings
are more anecdotal. One "fear" among some economists is that the
recent rise in Treasury Yields, which has brought about a decline
in mortgage refinancing, is that the consumer will not have has
much money to spend. Factory Orders may give future insight to
these fears being correct, or incorrect.
Durable Orders: or the Durable Goods report is the rate of
spending (up or down) on big-ticket items that we expect to last
at least three years. Televisions, refrigerators, office
furniture are products that make up this category, and similar to
the Factory Orders data, gives insight as to what types of
products consumers are buying. Are we rewarding ourselves with a
new shirt or blouse this month, or are we feeling wealthier and
buying that flat panel TV that just came out?
Industrial Production: was one of my FAVORITE classes in college
was industrial production. Running all those simulators and
trying to forecast what demand would be in order to set up my
production to efficiently meet that demand. This is one of those
economic reports that can also be grossly misinterpreted. Did
industrial production fall because of accurately perceived
economic slowing? Or did industry underestimate demand one
month, and have to ramp up production the next month to catch up?
We would be encouraged to monitor SALES at both the Business and
Wholesale level when trying to analyze Industrial Production
Capacity Utilization : is released along with Industrial
Production. Capacity Utilization at 100% would consider all
AVAILABLE production capacity, even if a portion of that capacity
had been shut down for 2-years. Capacity Utilization can be a
key reading in regards to inflation. Is there enough capacity
still yet to be utilized before "full capacity" is reached, where
demand is so great, that higher prices can be charged? 12 months
ago, capacity utilization was 74.2 and considered a recessionary
figure. Current levels are just starting to show Industrial
Production starting to build and economic slack from the
recession being absorbed.
Productivity: we touched on earlier. The United States is
thought to be a leader in technological advancements, and it is
from technological advancement that productivity can thrive.
Productivity measures are one of the key measures we should use
when interpreting other economic readings.
Nonfarm Payrolls: have been showing some life the past two
months. Here again, think about PRODUCTIVITY and what its impact
may have had, or still does have on the amount of workers needed
to perform a task. PRODUCTIVITY is good for cost efficiency, but
because of higher productivity rates, it may only take the work
of 1 to do what 2 workers did years ago. Earlier this year, it
was thought by some that the economy wasn't going to start
generating a meaningful number of jobs until early 2005. We've
seen the bond market's reaction to the stronger than expected
nonfarm payroll data the past two months.
Average Workweek: speaks to PRODUCTIVITY, but gives greater
insight as to demand building or contracting among businesses.
Since I started working for a living at age 18, I can't remember
working less that 40 hours a week.
Hourly Earnings: will be measured for a sense of not only wage
inflation, but the "quality" of job that might have been created.
This is another number that can be misconstrued if not looked
into. Is wage inflation being found if hourly wages rise? Or
are higher paying jobs being generated? This data can be found
inside the nonfarm payrolls data, and is broken down into many
categories like temporary help, leisure/hospitality, financial,
manufacturing, construction and several others. At this stage of
the economic recover, hourly earnings and wage costs are not an
overriding employment concern, where many economists also cite
strong PRODUCTIVITY growth trends limiting rising wage costs.
Consumer Confidence: is largely driven by a consumers view of
job availability, income, geopolitics and believe it or not....
stock market gains and losses. The reading indicated are derived
from survey questions, where responses are considered anecdotal.
Reading will be observed, but history shows that respondents
don't necessarily always ACT as they say they FEEL. I tend to
think of this as an emotional survey, where emotions can change
PPI and Core PPI: give us insight as to rising (inflation) or
falling (deflation) prices at the production/manufacturing level.
Many will dispute if these reading are an accurate measure of
prices at the manufacturing level. The Core PPI excludes the
more volatile food and energy components, as sometimes brief
imbalances in supply/demand due to weather or geopolitical events
should be brought into consideration when trying to interpret
price volatility at the manufacturing level.
CPI and Core CPI: give insight as to rising (inflation) or
falling (deflation) prices at the consumer level. Not unlike the
PPI data, there are disputes if these readings are accurate.
Here again, PRODUCTIVITY rates should be observed when making a
comparison of PPI to CPI data. While higher prices at the
producer level can be found, high rates of PRODUCTIVITY can allow
for steady pricing at the consumer level.
Treasury Budget: is a monthly account of the U.S. government's
surplus (more receipts than outlays) or deficit (more outlays
than receipts). The year-to-date deficit worsened by $80 billion
from a year earlier, while the 12-month deficit stands at $454
billion. My personal view is that while the deficit matters, at
this point of an economic cycle, which certainly appears to be
robust, tax receipts should begin to rise and help stem the rise
in the deficit. Economists currently see the 2004 deficit at
$370 billion, while the White House forecast is higher at $521
billion. I was critical of the Treasury when it told investors
it would cease auctioning off 30-year debt, when the long bond's
yield was falling. In my mind, if my cost of borrowing (when the
government sells/auctions off its bonds it is borrowing) is
falling, and I can borrow longer-term at a lower cost to borrow,
then that's where I would want to try and borrow. There are
criticisms to the size of the deficit and I have my criticisms
too. But if you're going to build a deficit in order to try and
turn an economy around to growth, while at the same time funding
a war, then the "best time" to do it is at 45-year lows rates of
borrowing. My core belief is that a strong economy will pay down
a deficit, and a weak economy will usually find a rising deficit.
Nonfarm payroll figures will be monitored closely as an
additional generator of tax receipts will be needed to eventually
pay down the deficit.
M2 Money Supply: shows growth, where this growth in money supply
has fueled what many economists call a "monetary led expansion."
Monthly M2 Money growth and velocity provide a very rough read on
the growth/inflation outlook over the intermediate term. Over
the long term, inflation is thought to be led by money growth.
However, this has become a point of dispute as recent evidence
isn't all that convincing as the 2001 M2 growth rate ran at the
fastest pace since 1983 as continued strong M2 growth in 2002 and
early 2003 had the Fed concerned about DEFLATION risks. In late
2003, M2 fell as economic growth surged and money flowed to
higher yielding investments from commercial banks, which is not
Fed policy related. Some of the inflation fears you may be
hearing about, in regards to the surge in money supply may not
fully account for the possibility that the renewed growth in
money supply may not necessarily be Fed driven, but commercial
banks capturing profit from prior investments. In a prior Ask
the Analyst (07/20/03) column titled "Money supply is surging,
but where's it going?" greater detail of M1, M2 and M3 money
supply is discussed. Has anyone noticed that stock prices have
fallen lately, while money supply has grown? Is Fed policy
currently in error and the rise in money supply a sign of
Well that's it for Econ 101.
Below these various economic indicators/reports, I've placed the
recent closing values of various market indices we will discuss
and analyze throughout time. Only the Fed funds rate is derived
by one body, the Federal Open Market Committee, while all others
are derived by the MARKET (you, me and others).
The one point I would want to make is in regards to questions
regarding just ONE economic report and trying to analyze the
stock or bond market in the scope of that one specific report.
Late last year, one analyst said he thought stock prices were
going to fall because M2 had stalled and actually showed a
decline. That looks to have been a good call.
It's interesting though that while M2 was growing rabidly in
2003, it was the rising price of gold that was this signal along
with a rising M2 that was spelling future inflation.
That is until gold fell, but now M2 rises, that gold is not
really the indicator for inflation, but instead, its M2. Wait,
no.... M2 was rising in 2003 and there wasn't inflation.
Oh... wait a minute. The rising dollar is the signal for
inflation that will bust the stock market bubble. Ooops! The
dollar was strong during the great bull market of the 1990's.
Aha! It's the rising deficit and lack of job growth combined
with rising commodity prices that will.......
Don't get confused and feel that you have to FULLY comprehend
every detail of economic data, and fully comprehend what that ONE
single report is saying, but it does help to have a basic
understanding of how many of the reports combined create the
bigger economic picture.
Don't be confused, or swayed by the friend that tells you just
because Business Inventories are trending lower, that it is a
sure sign of economic slowing. Ask them what there views are on
the decline in Business Inventories as it relates to rising sales
and the current rate of productivity.
Is the disparity between Producer Prices and Consumer Prices a
governmental plot to mislead economists and investors? Or does
productivity, have something to do with the disparity?