The sharp rise in new construction last month lifts the level of starts to the highest number since February 2008. Another way to consider the data: starts are now running at about twice as high as compared with the number posted during the depths of the Great Recession. The pace of new construction is still roughly 50% under the high points of the housing boom, although some of that was simply excess building that had little if any economic rationale. In any case, it’s clear that housing has recovered quite a lot of lost ground since this market imploded a few years back.

The strong profile that emerges in today’s data minimizes the worrisome signs that had been casting shadows recently. The year-over-year figures for both starts and permits had been trending lower through most of 2013. It wasn’t clear if this was a maturing of the housing recovery or something darker. The future’s still uncertain, of course, but today’s numbers on starts suggests that new construction is in no danger of slipping off the cyclical cliff any time soon.

Although the annual rate of starts turned sharply higher in November, the growth of permits relative to the year-earlier number is closing in on the lowest pace since 2010. For the moment, this isn’t terribly troubling because the current year-over-year pace of around 8% still suggests a healthy round of growth for home building. In fact, that’s the message in this week’s December update of the National Association of Home Builders/Wells Fargo Housing Market Index, which jumped to an eight-year high. “This is definitely an encouraging sign as we move into 2014,” said NAHB Chairman Rick Judson earlier this week. Today’s news on housing starts only strengthens Judson’s outlook.

What’s the risk for housing? Higher interest rates… maybe. When the Federal Reserve starts winding down its stimulus program, rates will move northward. In fact, rates have already moved moderately higher in recent months in anticipation that extraordinary run of monetary stimulus is nearing an end. The 30-Year conventional mortgage rate is currently around 4.4% (based on the national average), or up from roughly 100 basis points since the Spring. For the moment, it’s not obvious that higher rates will damage the housing recovery. But much depends on how fast rates rise and why they rise. If the Fed is tightening policy because economic growth is picking up, that’s a healthy change. For the moment, that’s still a reasonable bet.

Using a set of proxy ETFs to assess the damage, it’s clear that there’s been almost no place to hide when it comes to Treasuries lately. For perspective, let’s also compare US government bonds with the other major sectors of domestic debt for these United States for the trailing 250-day trading period (roughly the equivalent of one year) through yesterday, December 16:

Here’s how the numbers stack up after rebasing the prices of the bond ETFs to 100 as of December 18, 2012. Not surprisingly, the biggest losses are concentrated in the longest maturities, represented here by the iShares 20+ Year Treasury Bond ETF (TLT), which has shed more than 12% over the past 250 trading days:

As you can see, not every corner of the US bond realm is suffering, at least not yet. Leading the charge with profits: US junk bonds via the SPDR Barclays High Yield Bond ETF (JNK), which is currently higher over the past 250 trading days by slightly more than 5%. Short-term investment-grade corporates (CSJ) also show a slight gain. Even short-term Treasuries (SHY) are in the black, albeit just barely.

The lesson, of course, is to refrain from thinking of US bonds as a monolithic asset class when it comes to portfolio design and rebalancing decisions.

Another way of evaluating relative returns (and considering the historical context in the process) is calculating a rolling 1-year return spread. Let’s take the 1-year return for small caps and subtract the 1-year return for large caps, with the results plotted daily since the mid-1990s:

Using the chart above as a guide, the current small-cap rally has been running strong for more than a year. Although momentum has faltered a bit lately, the small-cap premium is still at a comparatively elevated level at around +8 percentage points. Yes, it’s been higher at times, including a brief, fleeting period in 2000 when the small-cap edge was closing in on an extraordinary spread of +40 percentage points. By that standard, the current premium looks moderate.

The question is whether it’s wise to hold out for even greater gains vs. rebalancing now and taking some profits? Minds will differ, as always, but the track record of reaching for the stars often comes to tears in the money game. That doesn’t mean that small caps won’t continue to dispense outsized returns over large caps in the year ahead. Perhaps, then, it’s wise to rebalance moderately. All or nothing investment decisions can lead to stellar results, but if you’re wrong you’ll pay a hefty price.

Decisions, decisions, although it’s always a good idea to start with first principles before going off the deep end. If you’re inclined to see investing as a risk-management process rather than a return-chasing endeavor, the numbers usually tell you most of what you need to know and when you need to act.

Meantime, it’s hard not to be impressed with the latest numbers. Industrial production’s 1.1% surge for November is the best rate of monthly growth in a year. The sight of the manufacturing slice of activity inching higher in November only strengthens the case for arguing that the expansion in the industrial sector is widespread.

More importantly, the year-over-year numbers show that industrial production’s pace has rebounded in recent months. For the first time since mid-2012, the Fed’s industrial production index has posted annual rates of growth above 3% for three months running. The deceleration that afflicted this indicator in the first half of this year (the low point was this past July’s dip to a mere 1.5% gain over the year-earlier month) has since given way to a substantially stronger set of comparisons.

We also learned today that the initial estimate of the US Manufacturing PMI for December continues to signal a healthy rate of growth through the end of 2013. “The flash PMI remained surprisingly high in December, suggesting strong growth momentum in the goods producing sector,” noted Markit’s chief economist in today’s press release (pdf). That’s a clue for thinking that the encouraging numbers in today’s November industrial production data will carry over into this month when the Fed publishes its next report for this indicator.

It may be a shock in some circles to discover that industrial activity has been growing by 3%-plus a year in recent months, but the broader implications for the business cycle aren’t terribly surprising. Although some pundits are prone to anecdotal evidence and outlier numbers in the regular updates on economic data, a broad review of the big-picture trend has remained consistently upbeat, as the monthly reviews of the Economic Trend & Momentum indices remind (here’s last month’s report, for instance).

Although the strong rise in industrial production for November is only one number, it’s one of several data points that suggest that business cycle risk remains low for the US. That’s been the message all along, albeit with some rocky periods at times. But an objective, broad-minded search for compelling clues that a new recession is near have turned up few persuasive warning signs in recent history. Today’s news on industrial production certainly doesn’t change this record.

Monday’s November report on US industrial production (scheduled for release on Dec. 16) is projected to post a 0.3% rise vs. the previous month, based on The Capital Spectator’s average econometric forecast. The expected gain marks a modest rebound after October’s 0.1% decline. Meanwhile, the Capital Spectator’s average projection for November is a bit lower than a consensus forecast via a survey of economists.
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Europe’s economic crisis could be mutating again
Barry Eichengreen (The Guardian) | Dec 10
Deflation could be replacing debt as the main problem – and there’s nothing to suggest the ECB is up to the job.
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Today’s economic reports look strikingly bipolar. First the good news: retail sales rose a healthy 0.7% in November vs. the previous month—a bit faster than The Capital Spectator’s average econometric forecast but in line with the consensus outlook. This morning’s update on initial jobless claims is another story. Filings for unemployment benefits surged 68,000 last week to a seasonally adjusted 368,000—the highest since early October. What’s going on here? Should we cheer, cry, or take the middle road and assume that we’re in another period of mixed messages and rising uncertainty? For some perspective, let’s dive into the numbers.
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It seems that crowd is increasingly inclined to expect that the Federal Reserve will begin to slow its bond-buying program next week, at the conclusion of its FOMC policy meeting on Wednesday, Dec. 18. Yesterday’s sharp drop in the US stock market is one sign that the Mr. Market is preparing for a change in the monetary weather in a few days. But is this fate? One reason for remaining a skeptic: inflation, which still looks quite low relative to the Fed’s target.
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The US economic trend, after strengthening in late-October through mid-November, has pulled back from its recent highs in the last several weeks, based on a markets-based profile of macro conditions. The Macro-Markets Risk Index (MMRI) closed at 13.0% on Tuesday, Dec. 10, a level that still suggests that business cycle risk remains low. The current 13.0% value is well above the lowest reading for the year to date—7.5% in mid-September—and comfortably above the 0% danger zone. If MMRI falls under 0%, that would be a sign that recession risk is elevated. By comparison, readings above 0% imply a bias for economic growth.

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US retail sales are expected to rise 0.5% in Thursday’s update (Dec. 12) for November vs. the previous month, according to The Capital Spectator’s average econometric forecast. The prediction is slightly higher than the previously reported 0.4% increase for October. Meanwhile, the Capital Spectator’s average projection for November is slightly below consensus estimates based on recent surveys of economists.

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