The consumers’ capacity for spending come hell or high water is widely recognized and celebrated. But yesterday’s retail sales report for October offers another excuse to pause and reconsider if more of the same is in store for 2007.
As the chart below illustrates, there’s reason to wonder if Joe Sixpack’s finally met his match and is now in the process of turning a new leaf that deemphasizes spending. For the second month running, retail sales slipped. Considering that August sales were flat, you have to go back to July to find a month when consumption overall advanced over the previous month.

And, no, stripping out the volatile motor vehicle sales doesn’t alter the downward bias in retail sales.
Similarly, a closer look at October’s retail sales doesn’t offer much improvement over the big picture. Yes, on a 12-month basis, growth is still evident. But what have you done for us lately? At best, the answer is mixed as the red ink in the one-month column below reveals.

If consumer spending continues to slow, the stakes will rise in the forecast by some that the worst of the real estate correction is behind us. If that proves to be a premature notion, Joe will have to step up to the plate once more to keep the economy afloat. With the holiday-spending season upon us, there’s a chance that a fresh surge of consumption may be coming. Even so, with real estate and consumption moderating, the economy can’t afford much else to go wrong now.

This morning’s update on producer prices couldn’t be any clearer: disinflation (deflation?) is alive and well in the wholesale marketplace.
Producer prices fell 1.6% last month, the largest monthly decline in five years, and the second in a row, coming on the heels of September’s 1.3% stumble. As a result, wholesale prices for the past 12 months through October are off 1.5%–the first year-over-year decline in four years.
Once again, the descent of energy prices is the major catalyst for a lower producer price index. Energy-related goods tumbled 5.0% in October, following an 8.4% decline in September.
Alas, energy prices can’t fall indefinitely. In fact, there are signs that prices of crude oil and gasoline are stabilizing. For oil, the $60-a-barrel level appears to be a floor, at least for the moment. The December ’06 crude contract on the NYMEX was changing hands at around $59 this morning. That’s down from around $80 in July. Gasoline, meanwhile, seems intent on hovering in the $1.50-$1.60 range (as per the December ’06 contract), which is also down sharply from around $2 a gallon back in July.
But lest we think that price stability seems the path of least resistance for energy at the moment, one analyst crunches the numbers and contemplates an alternative future. “The distortion of the commodity futures curve by financial investment is the greatest challenge to the stability of the crude and natural gas markets in the last 10 years,” wrote Ben Dell, a member of the energy research team in the London office of Sanford Bernstein, in a research note to clients today.

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In the November issue of Wealth Manager, your editor quizzed Armand Yambao, head of financial modeling at EnnisKnupp & Associates, a Chicago institutional investment consultancy that oversees $700 billion in assets. The subject of our exchange is everyone’s perennial favorite on matters financial: the future. In particular, what is EnnisKnupp telling clients to expect for risk and reward among the major asset classes? All the usual caveats apply, of course, when it comes to predictions. Indeed, no one knows what’s coming, but that doesn’t mean we shouldn’t talk about the tomorrow and beyond. Just don’t confuse forecasting with fate. Otherwise, enjoy….

With core inflation creeping higher, the focus on monetary policy necessarily increases. The question, of course: What is the right monetary policy?
Fed Chairman Ben Bernanke is the strategist in chief for managing the nation’s money supply. On paper, he’s eminently qualified, courtesy of his career as a professor of monetary economics at Princeton. The jury’s still out on his talents as practiced in the real world, however. But each day, another round of deliberations commence.
The latest exhibit offered for review comes by way of a
speech Bernanke gave today in Frankfurt, Germany. For those who give the chief the benefit of the doubt, the latest lecture merely reflects an academic’s overview of the history of monetary policy. No less was expected for a talk labeled “Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective.”
On first reading, the printed version of the talk lives up to its billing. Ben takes us on a whirlwind tour of monetary policy since the Fed’s 1913 founding. From the mistakes in the Great Depression to Friedman and Volcker and beyond, the current Fed head is nothing if not well-grounded in the evolutionary past that’s brought us to this monetary moment.
But skeptics, conspiracists and cranks may see things differently in today’s chat. For instance, might the Fed chief be laying the foundation to argue that the central bank’s influence on monetary policy is less than assumed? Consider, for instance, the following statements, as per today’s Frankfurt dialogue:
As I have already suggested, the rapid pace of financial innovation in the United States has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables.14 In response to regulatory changes and technological progress, U.S. banks have created new kinds of accounts and added features to existing accounts. More broadly, payments technologies and practices have changed substantially over the past few decades, and innovations (such as Internet banking) continue. As a result, patterns of usage of different types of transactions accounts have at times shifted rapidly and unpredictably.
Various special factors have also contributed to the observed instability. For example, between one-half and two-thirds of U.S. currency is held abroad. As a consequence, cross-border currency flows, which can be estimated only imprecisely, may lead to sharp changes in currency outstanding and in the monetary base that are largely unrelated to domestic conditions.
Also, consider this tidbit: “Although a heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the U.S. context, money growth may still contain important information about future economic developments.”
May? Hmmm. Sounds like one academic in government has a new strategy in mind. Details to follow…perhaps.

It’s not falling, but neither is it rising. Initial claims for unemployment insurance are more or less treading water relative to recent history.

This morning’s update from the Labor Department reveals that new filings for jobless benefits dropped by 20,000 for the week through November 4 from the previous week, on a seasonally adjusted basis. To put that in perspective, the 308,000 who filed for unemployment last week total slightly less than the weekly average stretching back over the past 10 weeks.
One implication: the economy’s not poised to fall into recession any time soon. Then again, growth doesn’t look set for a fresh burst either, based recent data from other corners of the economy. Of course, one can’t draw too many (if any) conclusions from one data series. In fact, prudence dictates to draw no conclusions for the moment until clearer signs emerge.
The bond market seems to be doing just that. After the yield on the 10-year Treasury consistently fell from July through September, tread water has become fashionable. The 10-year’s yield was 4.63% at yesterday’s close. Although the yield’s had a bit of a ride up and down over the past month or so, not much has changed since the bond bull market ran out of steam in mid-September.
Yes, we know that the economy’s slowing, based on recent data. But it’s not yet obvious how much it’s slowing, or how deeply. Finding an answer to that question will take time, and our guess is that we’ll all be celebrating New Year’s without much more concrete insight than we have here and now.
And so, absent extraordinary new economic numbers, the next few months could end up being a lot of light and heat without much new information. With the Democratic transition in Congress underway, all eyes are on what awaits in Washington for 2007. But the fun won’t start until February at the earliest.
Meanwhile, there’s plenty of economic data to pore over. Just don’t confuse new numbers with new information, at least not yet. Nap time anyone?

The world is a big place, but there’s a fair amount of uniformity when it comes to equity returns in 2006. Bull markets are everywhere. They vary in degree, of course. But from a regional perspective, at least, black ink ruled this year through October 31.
Fundamental valuation is another matter. There’s a bit more disparity when it comes to the usual array of valuation metrics. Let’s dive in and take a look, using data supplied by S&P/Citigroup Global Equity Indices through October 31, 2006.
Starting with total returns, European Emerging markets continue to lead the pack with a 36% total return (this and all returns quoted are dollar based). Even the worst performing region–Mid-East and Africa–is up 5.8%. A bullish tailwind, in other words, can be found in almost every corner of the globe’s stock markets, and so investors have had to work hard to lose money this year. Indeed, the World index has climbed 16.3% through last month. Meanwhile, U.S. stocks–although near the bottom of horse race in 2006 on a global basis–have advanced 12.3%, which is above-average on an historical basis.

The global equity profile becomes more complicated once we start looking at valuation. Latin America is the least expensive on a trailing 12-month price-earnings ratio basis. Trading at slightly above 12-times earnings, Latin America offers the best investor-friendly pricing by this measure when compared to everything else. U.S. stocks represent the highest-priced market by this definition in our survey, trading at nearly 18 times earnings.

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Former Fed Chairman Alan Greenspan spoke yesterday to an audience of roughly 3,000 at a financial advisor conference in Washington, D.C. hosted by Schwab Institutional. Your editor, attending on a press pass, was audience member 2,986.
Alan talked far and wide on matters fiscal and economic, but his commentary about the housing market was particularly intriguing. To cut to the chase, the maestro thinks that much of the correction in real estate has passed. To quote the former central banker: “It looks like the worst is behind us.” He expects a continuation of the current correction–or inventory adjustment, as Greenspan termed it. But a collapse doesn’t look imminent, nor does he think that the downdraft in housing will push the economy into a recession.
One reason for the optimism, he explained, is that single-family housing sales are running slightly ahead of new construction. Although sales are still vulnerable to falling, he said that it’s the rate of change that matters most for divining the future, as opposed to focusing on the actual number of sales now vs. some point in the past.

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Eugene Fama, a founding father of the efficient market theory, has a dialogue with Nina Mehtais in the Nov/Dec 2006 issue of Financial Engineering News and the conversation stirs up an old debate anew. Are markets efficient? Is it possible to pick winning stocks? Can investors beat the market? It’s an old discussion, but it promises to be a perennial one, and the latest installment from FEN is worth a look, no matter your view. A sample of the Q&A follows below. For the full interview, dive in here.
FEN: If markets are efficient, a stock price reflects the intrinsic value of a company, but does that mean the price is always right?
EF: It means you can’t figure out whether it’s wrong. It’s not always right because there’s some uncertainty about what right is, but basically you just can’t beat it.
FEN: How would you know if a market doesn’t fully reflect all available information about a stock?
EF: If you had the right risk and return story, you’d be able to identify the kinds of information that weren’t incorporated into the price. There are lots of studies where people study the adjustments of stock prices to splits, earnings announcements, mergers, everything. Another way is to look at the performance of active managers. They tout themselves as people who have information that’s not in the prices. Well, you can test that. Testing investment performance is basically testing market efficiency.
FEN: When is the market likely to be inefficient or to misprice securities?
EF: When it’s closed, I guess.
FEN: What about smaller, illiquid stocks?
EF: That’s what people claim – that smaller stocks are not priced as efficiently as bigger stocks, that emerging markets are not priced as efficiently as developed markets. But anyone who looks at it empirically can’t find any evidence to that effect.

Monetary policy is a thankless task these days. The trends are muddled, the numbers are in doubt, and every new data point unleashes a torrent of debate about what comes next as well as what just drove by. It doesn’t help that the stakes are fairly high too, i.e., inflation may or may not be a resurging threat.
Today’s October employment report delivers a fresh batch of numbers and new supply of fuzzy outlooks. Nonfarm payroll jobs rose by a seasonally adjusted 92,000 last month, the Bureau of Labor Statistics reported today. That’s the lowest since October 2005, when the blowback from Hurricane Katrina temporarily impaired the jobs machine. With no scapegoat this time around, last month’s thin rise in employment looks like the byproduct of a slowing economy. Jared Bernstein the Economic Policy Institute assumes this view, and offers some analysis today on that score.
But the more you look at the latest jobs report, the more nuanced it appears. Yes, an increase of just 92,000 new jobs looks discouraging and dangerously close to levels that look like a precursor to recession. On the other hand, the unemployment rate fell to 4.4% last month–the lowest since May 2001. One question to ask: are the foundations of recession laid on the back of falling unemployment? Since June 2003, when unemployment in the current cycle peaked at 6.3%, the trend ever since has been fairly consistently down.
At some point the trend will end, and no doubt we’re closer to the finish now than we were a year ago. Economic cycles haven’t been banished, despite the Fed’s best efforts. Then again, the magnitude of the cycles are smoother and less volatile, courtesy of central bank decisions that arguably have become more enlightened over the years. The goal of keeping expansions alive longer and minimizing the fallout from contractions has found a degree of success over the years. But such success has its costs, including the fact that employment booms aren’t what they used to be, which suggests that contractions may be milder and shorter too.
The counterspin is that the unemployment rate understates those looking for work. But the flaws were present in the past as well, and so the unemployment rate over time offers a fairly consistent profile of trend, flawed though it may be in terms of the absolute numbers. In any case, it’s reasonable to assume that the trend is reliably accurate; if so, the trend clearly reflects declining numbers of unemployed.
It’s also instructive to look at a breakdown of the employment picture last month. Virtually all of the weakness in the jobs picture comes in the so-called goods-producing areas of construction and manufacturing. Combined, the two groups shed 60,000 jobs in October. But goods-producing employment is a fraction of total nonfarm employment at about 16%. Suffice to say, employment trends in the United States aren’t dependent on what unfolds in the goods-producing industries. Manufacturing employment has been declining for years and so at this late dates it’s not persuasive to declare that the economy’s in trouble solely because this industry’s losing workers. That’s been true for 20 years or so, and yet the economy seems to have weathered the trend.
So, where’s the growth? Services, of course. The services sector overall harbors 84% of nonfarm employment. As a result, if you want a representive sample of employment trends in America, look first and foremost to services industries, such as retail trade, professional and business services, and education and healthcare businesses. By that measure, the trend is up. Services employment rose 152,000 last month. That’s a 1.6% jump, the fastest since March. Job creation is services, in other words, is alive and well, and for the moment at least the pace of creation is accelerating.
All of which leads us back to the Federal Reserve, which, we submit, faces more evidence today that the labor market continues to percolate, a trend that makes the notion of cutting interest rates that much more remote. Yes, there’s a risk that fallout from real estate may still deliver more pain. But the question is whether the pain will overwhelm the jobs machine now on view in the services sector? Judging by the latest numbers, the answer seems to be “no.” But pessimism, like its counterpart in hope, also springs eternal.

This morning’s news that productivity unexpectedly evaporated in the third quarter is bad news that comes at a vulnerable point in the economic cycle. With core inflation and labor costs creeping up, this isn’t the ideal moment to learn that productivity is missing in action.
But missing it is. The Bureau of Labor Statistics today reported that non-farm business-sector labor productivity was one large goose egg during July through September. Zero. Zilch. That’s down from 1.2% in the second quarter and 4.3% in the first. The consensus outlook was looking for something around 1%-plus.
The overall trend doesn’t bode well for remaining optimistic about inflation, at least for the near term. About two-thirds of the cost of manufacturing goods or delivering services is tied to labor costs. As a result, lower productivity (or the 60-minute output of one worker) raises business costs. Lower productivity gives inflation a stronger foothold in the medium term because it raises labor costs, and firms may try to pass off the higher costs by raising prices more than they otherwise would. Or so some economists reason.
Falling productivity by itself is only one factor, of course. Alas, today’s productivity news comes on the heels of Tuesday’s report of accelerating labor costs. The Labor Department’s employment cost index jumped 1% in the third quarter, the fastest quarterly pace in more than two years.
A cut in the Fed funds target rate looks increasingly remote for the foreseeable future. The question is whether the Fed will feel compelled to raise rates when it meets next month. Once again, that depends on the numbers that come out between now and then. But if statistical salvation is coming, it needs to come soon. Monetary policy, after all, is no quick fix for bubbling inflation pressures. What Bernanke and company do today will have an effect in a year or two. The Fed can wait for more data, but it can’t wait forever. The clock, as always, is ticking, and it seems to be ticking faster with every new data update.