All of the market-moving news this week seemed to come from outside the United States.
The bulk of the news dealt with slowing growth in China. For those who didn't believe the Chinese government a couple of weeks ago when they reined in their growth prospects (to a mere 7.5%), this week's news more or less confirmed those warnings. The week started with news that Australian miners were reporting a weakening of orders from China. Then later in the week the most recent set of purchasing managers' reports out of China showed another small decline. Then, to top off the week, some shippers noted a slowing in demand because of softening international trade and a general move toward cheaper but slower shipping alternatives. FedEx(FDX) even announced that it planned to send a few of its jets to the desert for storage to realign supply and demand.
The U.S. economic news this week was modest, with a lot of housing data for February, which, while improved, didn't look much better than January's. We are indeed off the housing bottom and the market appears to be holding at improved levels. Alas, no explosion on the upside for the housing market just yet, as we detail in this week's video. A couple of home pricing metrics looked a little better, but the more comprehensive news on pricing comes next week with the Case Shiller numbers on Tuesday.
Anecdotal evidence and conversations suggest a housing market a little stronger than the official data. For now, weather and massive seasonal factors are making the official data particularly hard to interpret. However, on a year-over-year, three-month moving average basis, there is no doubt that builder sentiment, housing starts, and existing-home sales are all improving.
Initial unemployment claims also made a new recovery low, now back to levels seen in 2008, almost four years ago.
My favorite weekly retail sales data is also improved this week and is off of the warning track for now.
Fallout From a Slowing ChinaIt looks like my thesis that a modestly slowing China is good news for the U.S. economy is going to be tested sooner than later. Given that exports to China represent less than 2% of U.S. GDP and a healthy portion of that is agricultural products, especially soybeans, a slowing China isn't likely to have a meaningful direct impact on the U.S. economy. Furthermore, a booming China has pushed up many commodity prices. Those higher prices have hurt the U.S. consumer in a big way, holding back the U.S. economy in 2011.
However, I don't want to be too Pollyanna-ish about a slowing Chinese economy. It will hurt certain manufacturers with large China exposures, such Caterpillar(CAT) and Joy Global(JOY). And unfortunately, it looks like a weaker China will have an impact on Europe, which already has its own set of problems. Major commodity exporters, including Australia and Brazil, will also be affected.
Interestingly, the biggest exporters to China are Japan, South Korea, and Taiwan. Yet each of these countries is much smaller than the eurozone 27 and the United States. It appears that emerging-market countries are in the direct line of fire of a slowing China while the developed economies are more likely to take a glancing blow.
Asia-Pacific Neighbors Are top Exporters to China
On the other side of the equation, China exports most of its goods to large developed markets, especially Europe. The eurozone 27 is by far the biggest market for China's exports, exceeding the United States by a healthy margin. Unfortunately for China, Europe's softness is already turning up in the trade data. Shipments from China to Europe that grew by 11% in the first quarter fell to a negative 3.7% rate in the third quarter of 2011.
China's Biggest Markets are Developed Economies
Putting it all together, a slowing Europe is a big deal to China because it is China's largest export market, and exports in general are a bigger portion of the Chinese economy. Flowing the other direction, as China slows, the most affected economies are likely to be its East Asian neighbors and commodity suppliers.
Europe and the United States will feel some impact too, but exports to China just aren't a very big number compared with the two largest economies. For some idea of scale, the eurozone exported nearly as many goods to Switzerland in 2010 as it did to China (surprisingly, Switzerland is not a eurozone member, despite its location). Driving home the point, Mexico is twice as big an export market for the United States when compared with China. (Tongue firmly in cheek, we really need to start analyzing Mexican and Swiss purchasing manager data as much as we do Chinese data.) In terms of approximate scale, the eurozone 27 is about a $17 trillion economy, the United States about $15 trillion, and China about $7 trillion, in 2011.
The question is, can China keep a small slowdown from turning into something more serious? Europe isn't going to get a lot better in the short run, though a stronger United States may pick up some of that slack. China's internal demand hasn't been spectacular as their booming housing market cooled and the relatively high inflation in 2011 took its toll (though inflation is now down meaningfully from its high). Some of the current economic slowing was engineered by the Chinese government by raising reserve banking requirements and interest rates and by tightening lending. This was all meant to bring down a booming 6%-plus inflation. And for now it's working; both the economy and inflation have slowed. In fact, they are slowly reversing the tightening, making some loans easier to get and reducing the reserve requirement (but not rates). Paradoxically, they are simultaneously raising the price of subsidized refined products, including gasoline, which may weigh on consumer spending.
Weather Muddies Domestic Housing DataMost of my analysis concerning the housing market is in this week's video. Because warm weather had inflated January numbers, economists weren't expecting a lot from this month's batch of housing data. And that is exactly what they got: not much.
Builder sentiment, that had seen stair-step, upward improvement from 11 to 28, took a breather in February, remaining at 28, but still well below the 50 level one would expect in a decent housing market. Sentiment is often a leading indicator of both housing starts and new-home sales. By the way, this February is still the best reading since 2007.
House starting and existing-home sales for February both looked better than a year ago. However, upward revisions to January data made February look slower than January even though the number hit widely held forecasts for the number of units. All the squiggles in the monthly reports distort a story that is really quite positive when looked at from a broader perspective. Adam Fleck, of our industrials team, took a slightly more bullish view of this month's housing data:
Existing-home sales up from a year ago, but favorable weather could play a part. The seasonally adjusted annual selling rate of existing homes jumped nearly 9% in February from the same month a year ago, led by strong sales of single-family units. We believe some of this strong increase probably stems from more favorable weather conditions, as this year's mild winter has likely drawn in some buyers earlier than last year's bitter cold, but inventories remain in good shape. Although inventories of existing homes--at 6.4 months of supply--climbed slightly from January's six months, with condo inventories at their highest level since October 2011, this figure is still almost 20% below year-ago levels and the lowest February months' supply since 2006.
New-home sales also climbed sharply year over year in February, jumping 11%, while available homes for sale declined nearly 18%. Although the SAAR--at 313,000--fell about 1.6% from January's 318,000, we're encouraged that median sales prices increased 11% sequentially and 6% from a year ago, to their highest level since June 2011.
Speaking of pricing, pricing data from the Federal Housing Finance Agency continued to show improvement in year-over-year results, as shown below. Based on some sloppy numbers a year ago, I suspect that this year-over-year metric will pop into positive territory for both February and March, at a minimum.
Month-to-month pricing data was basically unchanged, though prices were up in four of the nine U.S. regions. More importantly, prices have been up or flat for four of the last five months. Hopefully, these single-month numbers will begin to show up in the better-regarded Case Shiller three-month moving average price index that will be provided by next Tuesday.
Housing Parade of Data Continues; Personal Income, Spending Also on Docket
On the housing front, both pending home sales and the Case Shiller Price Indexes will be released early in the week. Pending home sales used to be a pretty good indicator of existing-home sales, which are reported almost four weeks later. However, poor appraisals and mortgage denial have caused some initial contracts (measured in the pending index) to fail to make it to final closing (existing-home sales). Pendings were up 2% sequentially last month, and I would expect a better performance for this month.
On the housing front, both pending home sales and the Case Shiller Price Indexes will be released early in the week. Pending home sales used to be a pretty good indicator of existing-home sales, which are reported almost four weeks later. However, poor appraisals and mortgage denial have caused some initial contracts (measured in the pending index) to fail to make it to final closing (existing-home sales). Pendings were up 2% sequentially last month, and I would expect a better performance for this month.
Case Shiller pricing data hasn't been nearly as positive as the FHFA data that we got this week, but I do expect that at the very least this index will show a slowing rate of decline. Then in the next month or two, I think we will have a serious shot at a positive increase in this index, which would provide a real psychological lift to consumer sentiment.
The all-important personal income and spending report for February is due at the end of the week. To be a little melodramatic, economists are expecting a tripling in consumption expenditures from 0.2% in January to 0.6% in February (monthly, not adjusted for inflation). An exceptionally strong retail sales report earlier in the month plus robust auto sales that somehow were not fully accounted for in January figures are the reason for everyone's optimism. The big mystery is if the inflation calculation will strip away a lot of those gains. Incomes, again not adjusted for inflation, are expected to grow a more modest 0.3%.
The durable numbers have been mixed recently, and I personally am not going to get worked up over these numbers either way. Highly volatile aircraft, car, and defense industry numbers distort this report and make interpretation difficult. January's orders were off a sharp 3.7% (sequentially, not year on year). So this month it's everyone on the other side of the boat with expectations for a 2.9% gain. Given the European-Chinese situation, I wouldn't be counting your chickens too far in advance by anticipating a strong durable goods report. But given the strong backlogs at a lot of manufacturers, and the relatively small size of the manufacturing sector, I don't think this report should really move the economic needle. But a bad report just might not be well received by the Street, which is already panicked over poor manufacturing numbers out of Europe and China this week.
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