Article: National Economic Conditions - 4th Quarter 2010

For the sixth consecutive quarter the U.S. Economy showed positive growth. However, a January 2011 press release issued by the Federal Open Market Committee (“FOMC”) expressed concern over the rate of economic recovery and the lack of a significant improvement in labor market conditions. Several factors were cited by the FOMC that attempt to explain the moderate rate of growth experienced during the fourth quarter of 2010, including:

• A continued high unemployment rate and modest income growth,
• Low levels of investment in nonresidential structures and a generally depressed housing sector, and
• An ongoing reluctance by many employers to add to their payrolls.

In a concerted effort to cultivate employment and price stability, as well as support a healthier economic recovery effort overall in 2011 and beyond, the members of the FOMC agreed that its existing policy of “reinvesting all principal payments from current securities holdings” will be maintained. Furthermore, the FOMC plans on purchasing $600 billion of longer-term Treasury securities by the end of the first half of 2011 in addition to maintaining the target range for the federal funds rate at 0 to ¼ percent.[1]

Gross Domestic Product

The most commonly cited measure of general economic conditions is growth in real GDP. Real GDP is the real (adjusted for inflation) dollar value of all goods and services produced within the country in a given period. The Bureau of Economic Analysis (“BEA”) quarterly measure of real GDP is seasonally adjusted at annual rates (SAAR), which means that the figure has been annualized with seasonal effects removed.

Real GDP increased 3.2% (SAAR) in the fourth quarter of 2010 from $13,278.50 billion to $13,382.60 billion after changes of 3.7%, 1.7%, and 2.6% during the first, second, and third quarters of 2010, respectively. Real GDP increased 2.9% in 2010, after changes of 1.9%, 0.0%, and -2.6% in 2007, 2008, and 2009 respectively.[2]

The acceleration in real GDP in the fourth quarter (2010) primarily reflected a sharp downturn in imports, an acceleration in PCE, and an upturn in residential fixed investment that were partly offset by downturns in private inventory investment and in federal government spending and a deceleration in nonresidential fixed investment.[3]

In November, the FOMC predicted that real GDP growth would have a central tendency between 2.4% and 2.5%, between 3.0% and 3.6%, between 3.6% and 4.5%, and between 3.5% and 4.6% during 2010, 2011, 2012, and 2013, respectively. In its long-run projection,[4] the FOMC expected real GDP growth would have central tendencies between 2.5% and 2.8%.[5]

The fourth quarter Philadelphia Federal Reserve Survey of Professional Forecasters (the “Philly Survey”) predicted real GDP growth of 2.4%, 2.7%, 3.3%, and 2.9% during the first through fourth quarters of 2011, respectively. The Philly Survey further predicted growth of 2.5%, 2.9%, and 3.0% during 2011, 2012, and 2013, respectively.[6]

The December Wall Street Journal survey of economic forecasters (the “WSJ Survey”) predicted real GDP growth of 2.6% for the final quarter of 2010. The WSJ Survey further predicted growth rates of 2.7%, 2.9%, 3.1%, and 3.2% for the first through fourth quarters of 2011, respectively. Annually, the WSJ Survey predicted growth rates of 2.7% and 3.0% for 2010 and 2011, respectively.[7]

According to the WSJ Survey,

…the majority of the respondents also say that there is a better chance the economy in 2011 will outperform their forecasts than that it will underperform… 71% of economists said the risks to their forecasts are more to the upside, while 29% said the risk was to the downside.[8]

[9]

Prices and Inflation

Inflation is the ongoing increase in the general level of prices of goods and services in an economy. The Consumer Price Index (CPI) is the most commonly cited measure of inflation. The CPI measures the price of a standard market basket of goods designed to be representative of the items purchased by a typical urban consumer.

The CPI increased approximately 0.9% during the fourth quarter of 2010 from 218.4 to 220.3 (1982-1984=100, seasonally adjusted) after changes of 0.2%, -0.4%, 0.7% in the first, second, and third quarters of 2010, respectively. The fourth quarter increase put the CPI at an increase of 1.6% during the last twelve months, compared to growth during 2006, 2007, 2008, and 2009 of 3.2%, 2.8%, 3.8%, and -0.36% respectively.[10]           

The Philly Survey anticipates growth in the CPI to be between 1.3% and 1.8% (SAAR) for each quarter from the second quarter of 2010 to the fourth quarter of 2011. The Philly Survey predicted CPI growth of 1.6%, and 1.9% in 2011, and 2012 respectively.[11]

The WSJ Survey predicted the CPI would grow 1.8% during the last twelve months ended June 2011, and December 2011, respectively.[12] Economists at Bank of America/Merrill Lynch (“BAC economists”) expected the CPI to increase 1.6% (SAAR) and 1.1% during 2011 and 2012, respectively.[13]

The CPI for food increased 0.4% during the fourth quarter of 2010 from 220.3 to 221.1 (1982-1984=100) after changes of 0.7%, and 0.2%, and 0.4% in the first, second, and third quarters of 2010, respectively. The CPI for food increased 0.7% during the last twelve months, after changes of 2.4%, 4.0%, 5.5%, and 1.8% in 2006, 2007, 2008, and 2009, respectively.[14]

The CPI for energy increased 7.57% during the fourth quarter of 2010 from 210.3 to 226.2 (1982-1984=100) after changes of 2.2%, -7.1%, and 5.6% during the first, second, and third quarters of 2010, respectively. The third quarter increase put growth in the CPI for energy at 9.5% during the last twelve months. The CPI for energy had changes of 11.2%, 5.5%, 13.9%, and -18.4% in 2006, 2007, 2008, and 2009, respectively.[15]

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During the December meeting, the FOMC projected that inflation would “remain for some time below levels judged to be most consistent, over the long run”. The committee also noted that increases in the Federal Reserve’s balance sheet along with low short term interest rates could result in increased inflation. The committee agreed to increase the long term security holdings to promote a stronger economic recovery while ensuring inflation is consistent with the committee’s mandate.[17]

The Producer Price Index (PPI) is another commonly cited measure of inflation. The PPI measures the price of a standard market basket of goods designed to be representative of the items purchased by a typical producer. The PPI for all finished goods increased 2.3% during the fourth quarter of 2010 from 180.2 to 184.4 (1982=100), after changes of 1.6%, -0.9%, and 1.1% in the first, second, and third quarters of 2010, respectively. The PPI for all finished goods increased 4.3% during the last twelve months, while the index had changes of 3.0%, 3.9%, 6.3%, and -2.6% during 2006, 2007, 2008, and 2009, respectively.[18]

[19]

The average price per barrel of oil increased during the fourth quarter of 2010 from an average of $75.24 in September 2010 to an average of $89.15 in December 2010. The price increased 19.7% during the last twelve months.[20] The WSJ Survey predicted the price per barrel of oil would be $86.62 and $88.26 by June 30, 2011, and December 31, 2011, respectively.[21] IBISWorld estimated that the price of oil increased 26.3% in 2010; furthermore, IBISWorld predicts an average annual rate of 5.8% between 2011 and 2016.[22]

[23]

Trade Deficit

Real net exports increased from a third quarter total of -$505.0 billion (SAAR) to -$392.2 billion during the fourth quarter of 2010. The third quarter level of net exports was preceded by real net exports of -$330.1 billion, -$338.4 billion, and -$449.0 in the fourth quarter of 2009 and the first and second quarters of 2010, respectively. Until the completion of 2010, real net exports had consistently increased (become less negative) with levels of -$729.2, -$654.9 billion, -$504.1 billion, and -$363.0 billion during 2006, 2007, 2008, and 2009, respectively. However, the prevailing trend reversed in 2010 and real net exports decreased to -$421.1.[24]

The Philly Survey predicts that real net exports will increase from -$499.3 billion in the fourth quarter of 2010 to -$498.5 billion in the first quarter of 2011. Proceeding forecasts estimate that real net exports will decline slightly throughout 2011 and finish the fourth quarter at -$499.9 billion. In addition, the Philly Survey expects the annual level of real net exports to finish 2010 at -$450.8 billion, while real net exports for 2011 are expected to decrease to -$504.0.[25]

BAC economists project that real net exports will reach -$421.2 billion, -$400.9 billion, and -$409.7 billion during 2010, 2011, and 2012, respectively.[26]

[27]

Interest Rates

Interest rates remained stable or decreased slightly during the fourth quarter of 2010. The discount window rate remained constant at 0.75%. The 0.75% rate is an increase from the rate of interest prevalent throughout 2009 of 0.50%, a historically low rate that was the result of a downward trend that began in July 2007 (6.25%).[28]

The federal funds rate decreased 1 basis point during the fourth quarter from 0.19% to 0.18%. The current rate represents a 6 basis point increase during the last twelve months.[29] The FOMC announced in December it would keep its target for the federal funds rate between 0.00% and 0.25% because it:

…continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.[30]

According to The Wall Street Journal,

Economists surveyed by The Wall Street Journal are increasingly optimistic about the pace of the recovery, predicting the U.S. will grow at better than a 3.2% annual rate in each quarter this year.

With little pressure on the inflation front and a slow recovery in the job market, most of the economists don’t expect the Fed to start raising interest rates until early 2012 at the earliest (in an effort to promote full employment and price stability)…As the recovery moves forward, they [the economists] expect the central bank to keep mostly to the sidelines.[31]

Some economists believe the FOMC will increase its target for the federal funds rate at a later date than previously expected. The WSJ Survey, whose participating economists predicted in September that the federal funds rate would decrease to 0.16% by December 31, 2010 (down from the 0.34% projected for December 31, 2010 in June), predicted in mid-December that the federal funds rate would reach only 0.15%, and would reach 0.21% by June 30, 2011 and 0.46% by December 31, 2011.[32] In January 2011, BAC economists predicted no change would be made to the federal funds target rate for at least a year.[33]

The yield to maturity on 20-year U.S. Treasury bonds increased 70 basis points in the fourth quarter of 2010 from 3.47% to 4.17%. The yield decreased 23 basis points during the last twelve months.[34] The average yield to maturity on Aaa rated (Moody’s) corporate bonds increased 49 basis points in the fourth quarter from 4.53% to 5.02%. The yield decreased 24 basis points during the last twelve months.[35]

[36]

Financial Markets

The Dow Jones Industrial Average (DJIA) increased 7.3% in the fourth quarter of 2010 from 10,788.05 to 11,577.51 after changes of 4.1%, and -10.0%, and 10.4% during the first, second, and third quarters of 2010, respectively. The DJIA increased 11.0% in the last twelve months relative to changes of 16.3%, 6.4%, -33.8%, and 18.8% during 2006, 2007, 2008, and 2009, respectively. The DJIA peaked on October 11, 2007 at 14,279.96 and reached a low of 6,440.08 on March 9, 2009.[37]

The S&P 500 closed the fourth quarter at 1,257.64, a 10.2% increase from the third quarter close of 1,141.20. The fourth quarter close came after changes of 4.9%, -11.9%, and 10.7% during the first, second, and third quarters of 2010, respectively. The index increased 12.8% during the last twelve months. Historically, the index had changes of 13.6%, 3.5%, -38.5%, and 23.5% in 2006, 2007, 2008, and 2009, respectively. The S&P 500 hit a high of 1,576.09 on October 11, 2007, and a recent low of 666.79 on March 6, 2009.[38]

The NASDAQ Composite Index increased 12.0% in the fourth quarter of 2010 from 2,368.62 to 2652.87. The fourth quarter increase came after changes of 5.7%, -12.0%, and 12.3% during the first, second, and third quarters of 2010, respectively. The index increased 16.9% during last twelve months. The NASDAQ had changes of 9.5%, 9.8%, -40.5%, and 43.9% in 2006, 2007, 2008, and 2009, respectively. The NASDAQ reached its recent high of 2,861.51 on October 31, 2007 and a recent low of 1,265.52 on March 9, 2009.[39]

[40]

Housing, Construction, and Real Estate

Average mortgage rates for 30 year fixed mortgages increased 36 basis points in the fourth quarter of 2010 from 4.35% to 4.71%. The average rate decreased 22 basis points during the last twelve months.[41] According to IBISWorld, the 30-year conventional mortgage rate for 2010 was approximately 4.90%. Furthermore, IBISWorld projects the average 30-year mortgage rate to be 4.51%, 5.02%, 5.39%, 5.81%, and 6.27% for 2011 through 2015, respectively.[42]

[43]

Despite the low cost of financing, the housing market continued to remain generally depressed. Housing starts decreased 12.0% during the fourth quarter of 2010 from 601,000 (SAAR) to 529,000. This decrease came after changes of 10.1%, -15.0%, and 11.5% during the first, second, and third quarters of 2010, respectively. Housing starts decreased 8.2% during 2010. Likewise, housing starts decreased 17.3%, 37.1%, and 46.0% during 2006, 2007, and 2008, respectively, but increased 2.9% during 2009.[44]

The Philly Survey projected total housing starts would reach approximately 610,000 and 640,000 in the fourth quarter of 2010 and first quarter of 2011, respectively, with an increase to 760,000 starts by the fourth quarter of the same year. Furthermore, the Philly Survey predicted annual figures for housing starts of 600,000 and 700,000 houses for 2010 and 2011, respectively. Housing starts hit its recent peak at 2.3 million in January 2006.[45]

In December, the WSJ Survey predicted housing starts would reach 600,000 and 730,000 in 2010 and 2011, respectively.[46] Likewise, BAC economists predicted that housing starts would reach 538,000 by 2010 and 732,000 by 2011.[47]

Houses sold increased by 3.8% from 317,000 (SAAR) to 329,000 during the fourth quarter of 2010. This increase came after changes of 7.9%, -19.3%, and 2.3% during the first, second, and third quarters of 2010, respectively. The August 2010 figure of 274,000 was the lowest in recorded history (data dates back to January 1959). Houses sold (NSA) decreased 14.4% during 2010 compared to decreases of 18.1%, 26.2%, 37.5%, and 22.7% during 2006, 2007, 2008, and 2009, respectively.[48]

Houses for sale decreased 5.9% from 202,000 (SAAR) to 190,000 during the fourth quarter of 2010 after decreases of 1.3%, 7.5%, and 4.3 in the first, second, and third quarters of 2010, respectively. Fourth quarter totals of 190,000 houses for sale was the lowest since January 1968 (189,000). Houses for sale decreased 17.7% during 2010, compared to changes of 4.3%, -7.6%, -29.0%, and ‑34.1% in 2006, 2007, 2008, and 2009, respectively.[49]

The months of supply for houses represents the number of months it would take to sell all of the houses currently for sale at the current sales rate (seasonally adjusted). The months of supply of houses for sale decreased during the fourth quarter of 2010 from 7.6 to 6.9.[50] The months of supply of houses for sale decreased 11.5% during 2010,[51] compared to changes of 32.7%, 47.7%, 16.7%, and -30.4% from December to December of the years from 2005 to 2009, respectively.[52]

[53]

Unemployment

The unemployment rate decreased twenty basis points to 9.4% during the fourth quarter of 2010. This decrease came after changes of ‑20, -20, and 10 basis points during the first, second, and third quarters of 2010, respectively. The rate also increased thirty basis points during the last twelve months and had annual changes of -50, 0, 120, and 350 basis points during the years from 2006 to 2009, respectively.[54] In November, the FOMC predicted that the rate would have central tendencies between 8.9% and 9.1%, between 7.7% and 8.2%, and between 6.9% and 7.4% during 2010, 2011, and 2012, respectively. The long-run projection of the FOMC predicted the central tendency of unemployment between 5.0% and 6.0%.[55] The Philly Survey predicted unemployment rates of 9.3%, 8.7%, and 7.9% during 2011, 2012, and 2013, respectively.[56] The WSJ Survey predicted the unemployment rate would be 9.4%, and 9.0% by June 2011, and December 2011, respectively.[57] BAC economists predicted the unemployment rate to be 9.4% and 8.9% in 2011 and 2012, respectively.[58]

[59]

Forward Looking Indicators

The Index of Consumer Sentiment (ICS) is a measure of overall consumer expectations and a predictor of consumer spending and economic conditions. A higher ICS indicates that consumers have higher confidence in the economy and are consequently more likely to spend. The ICS was 74.5 (1966=100) in December 2010, a 9.2% fourth quarter increase from September 2010 (68.2). The quarterly increase in consumer sentiment mentioned above followed changes of 1.5%, 3.3%, and -10.3% during the first, second, and third quarters of 2010, respectively. The ICS increased 2.8% in 2010. In comparison, the ICS experienced annual changes of 0.2%, -17.7%, -20.4%, and 20.6% in 2006, 2007, 2008, and 2009, respectively.[60]

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The following remarks were offered by the ICS’s Chief Economist regarding the results computed for 2010:

…Consumers have been increasingly concerned with rising food and fuel prices, and have noticed that fewer and smaller discounts are now available at stores and vehicle dealerships…Given that consumers do not anticipate renewed wage growth, they are likely to again engage in selective spending cutbacks. Consumers are now less able to smooth consumption by using credit cards since fewer households now have credit cards and those that have them are likely to have lower credit limits.[62]

In contrast, the Wall Street Journal suggested that despite the steady forward progress of economic recovery in the United States, consumers should remain cautious and not forget the recent past:

…Let’s not forget the hole in which Americans managed to spend themselves during the recession…People are saving less as they relax their budgets. The savings rate in December fell to 5.3% from 5.5%, as economic uncertainty becomes the norm and people tire of frugality…It’s good to see people feeling confident enough to spend, but until there’s some solid strength behind the gains, we should hold off on celebrating.[63]

Possible roadblocks to continued expansion through consumer spending were given in minor detail when one Wall Street Journal reporter added,

…The expansion [of economic output in the fourth quarter of 2010] in large part was fueled by a jump in consumer spending – a crucial change from earlier in the recovery, when growth relied heavily on businesses investing and building up inventories…To be sure, the economic outlook still has clouds. Some economists worry that the year-end spending splurge by consumers could ebb. Another serious challenge is unemployment, which stands at 9.4%.[64]

The Conference Board Leading Economic Index (LEI) is a signalling measure of the business cycle in which cyclical turning points of the LEI have historically taken place “before those in aggregate economic activity.” The LEI is an average of ten “leading” indicators.[65] The LEI increased 2.5% in the fourth quarter of 2010 from 109.7 to 112.4 (2004=100). This increase follows changes of 2.2%, 0.3%, and 0.5% for the first, second, and third quarters of 2010, respectively. The LEI increased 5.6% during the last twelve months, from 106.4 (December 2009) to 112.4.[66]

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The following excerpts regarding the release of December’s LEI were offered by member economists of the Conference Board:

…While the LEI points to an economic expansion that is gaining further traction, its components still suggest the expansion path may be uneven. December’s gain was led by housing permits, the interest rate spread, initial claims for unemployment insurance and consumer expectations.

…The four-month rise [in the LEI] suggests the economy now has some wind in its sails; however, it still faces some strong headwinds in the medium-term. Overall economic activity is likely to continue to gain momentum in 2011.[68]

Industrial Production

The Total Industrial Production Index, a measure of total output from industrial companies, increased 0.6% during the fourth quarter of 2010 from 93.7 to 94.3 (2007=100, seasonally adjusted), after changes of 1.73%, 1.80%, 1.6% in the first, second, and third quarters of 2010, respectively. The index increased 5.8% during the last twelve months. The index changed 2.2%, 2.7%, -3.3%, and -9.3% in 2006, 2007, 2008, and 2009, respectively.[69]

The Philly Survey predicted the index would increase 4.0% during 2011.[70] BAC economists predicted that the index would have changes of 3.9% and 3.8% in 2011 and 2012, respectively.[71]

The Capacity Utilization Rate measures the usage of the total production capacity of select U.S. industries (71 in manufacturing, 16 in mining, and 2 in utilities). The capacity utilization rate is calculated by dividing the seasonally adjusted output index by the capacity index of these industries.[72]

The capacity utilization rate increased approximately 40 basis points from 75.1% to 75.5% during the fourth quarter of 2010 after 136, 137, and 121 basis point increases during the first, second, and third quarters of 2010, respectively. The capacity utilization rate increased 423 basis points during the last twelve months. Historically, the rate had changed 62, 54, -337, and -789 basis points during 2006, 2007, 2008, and 2009, respectively.[73] BAC economists further predicted that capacity utilization would reach 77.1%, and 79.8% during 2011 and 2012, respectively.[74]

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This Decosimo Advisory Services National Economic Conditions report summarizes general economic conditions as of December 31, 2010. It was prepared as of January 31, 2011. Information was gathered from sources we believed to be reliable using data available as of the date shown in the respective footnote. DAS accepts no responsibility for the accuracy of information provided in this summary. No statement in this report is to be considered advice for any purpose. It is the responsibility of the user of this report to verify the accuracy of the information herein and to relate the information contained herein to the particular application of its use. Tables of Data referenced in footnotes are available on request from Decosimo Advisory Services.