Industrial Production Up

From the Federal Reserve:

Industrial production rose 0.5 percent in June after a decrease of 0.1 percent in May. At 113.4 percent of its 2002 average in June, total industrial production was 1.4 percent above its year-earlier level. Manufacturing output moved up 0.6 percent in June; excluding motor vehicles and parts, factory output increased 0.4 percent after having been unchanged in May. In June, the output indexes for mining and utilities registered gains of 0.5 percent and 0.3 percent respectively. For the second quarter as a whole, total industrial production advanced at an annual rate of 2.9 percent after an increase of 1.1 percent in the first quarter. Capacity utilization for total industry moved up to 81.7 percent in June; the rate was 0.6 percentage point below its level in June 2006 but 0.7 percentage point above its 1972-2006 average.

This jibes with yesterday's Empire State manufacturing report, which showed gains as well.

There were increases across the board: consumer goods, business equipment and construction all saw gains. Business equipment is up 3.4% Y/Y. However:

The index for business equipment was unchanged in June for a second consecutive month, but it advanced at an annual rate of 3.6 percent in the second quarter

Automotive production is ramping up:

After little change in the first quarter, the production of automotive products surged at an annual rate of 20.7 percent in the second quarter.

The housing slowdown is clearly having an effect:

The output of home electronics recovered 2.6 percent in June after a decline of the same amount in May. The index for appliances, furniture, and carpeting fell 0.5 percent in June; production increased at an annual rate of 0.8 percent in the second quarter after declines in each of the preceding six quarters.

One of the central themes of the bull's argument going forward is an increase in manufacturing capacity and activity. So far this month, we are getting a decent confirmation of that trend.

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PPI Down -.2%

From Bloomberg:

Prices paid to U.S. producers unexpectedly dropped for the first time in five months, restrained by declines in fuel and food costs.

The 0.2 percent fall followed a 0.9 percent increase in May, the Labor Department said today in Washington. Core prices, which exclude food and energy, rose 0.3 percent, reflecting a jump in automobile prices. Excluding passenger cars, core prices were up 0.1 percent.

The figures, coming a day before Federal Reserve Chairman Ben S. Bernanke testifies to Congress on the economy, would be welcome news for policy makers. Central bankers last month said a pickup in inflation remained the biggest risk and more evidence of a slowdown in prices would be needed before concern eased.

From the BLS:

The Producer Price Index for Finished Goods decreased 0.2 percent in June, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This decline followed advances of 0.9 percent in May and 0.7 percent in April. At the earlier stages of processing, prices received by producers of intermediate goods rose 0.5 percent in June after increasing 1.1 percent in the prior month, and the crude goods index moved up 0.3 percent following a 2.0-percent advance in May.

According to the BLS, energy prices decreased 1.1% in June and Food prices decreased .8% in June.

However -- consider the following charts:

The Goldman Sachs Agricultural futures index:



Light Sweet Crude Oil



However, also consider that gas prices decreased in June:

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Government Rules Out Theft

The government has ruled out topping up a pensions lifeboat fund with surplus unclaimed pensions cash from life insurers, ie it has ruled out theft of private money for use in public expenditure.

Andrew Young, of the Government Actuary's Department, said that non-tax sources of funding for the Financial Assistance Scheme FAS (inherited estate orphan assets, windfall taxes or an extension of existing levies on solvent occupational pension schemes) were largely unsuitable.

He noted that there would be:

"substantial legislative and administrative barriers to establishing such a scheme".

How annoying when the law blocks government plans for theft!

You can be assured that this will not be the last that we hear of this scheme, and that the government will be doing its best to try to find a way around these "legal obstacles".

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Rail Volumes Down in June

From the American Association of Railroads:

U.S. freight railroad carload traffic fell 2.7 percent in June 2007 compared with June 2006, while intermodal traffic fell 1.8 percent compared with the same month last year, the Association of American Railroads (AAR) reported today.

Overall, U.S. railroads originated 1,344,296 carloads of freight in June 2007, down 37,679 carloads (2.7 percent) from June 2006. U.S. railroads also originated 961,545 intermodal units in June 2007, a decrease of 17,956 trailers and containers (1.8 percent) from June 2006.

“Rail volumes remained relatively soft in June, though they are up against some very strong comparisons from last year,” noted AAR Vice President Craig F. Rockey. “Most economists are fairly upbeat about economic growth in the second half of this year, and when the economy does pick up, we can expect rail volumes to rise commensurately,” Rockey added.

Once again, Bonddad returns to the old Dow theory -- transports an transportation have to perform well for the economy to be doing well. The reason is simple -- goods have to be shipped somewhere. Declining rail traffic indicates the manufacturing expansion isn't happening as strongly as we would like.

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Empire State Index Shows Strength

From the NY Fed:

The Empire State Manufacturing Survey indicates that conditions for New York manufacturers continued to improve in July. The general business conditions index held near its June level, at 26.5.

The new orders index climbed for a fourth consecutive month to its highest level in more than a year, while the shipments index remained near its June level. The inventories index tumbled sharply into negative territory. The prices paid index, although elevated, eased modestly, as the prices received index held steady. Employment indexes were modestly positive. Future indexes conveyed significant optimism, with notable improvements in the outlook for employment and capital spending.

I'm a big fan of these regional Federal Reserve reports. They give us a nice regional picture of good, general business information.

This release gives us further confirmation of a strengthening manufacturing sector. However, the inventory questions could indicate a period of slowing activity in the next few months. That situation -- as with most in the economics realm -- will have to play out.

I should add that I am not a big fan of the future outlook question because it's really easy for those being polled to be really optimistic.

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Higher Energy Prices Are Here to Stay?

From the WSJ:

World oil and gas supplies from conventional sources are unlikely to keep up with rising global demand over the next 25 years, the U.S. petroleum industry says in a draft report of a study commissioned by the government.

In the draft report, oil-industry leaders acknowledge the world will need to develop all the supplemental sources of energy it can -- ranging from biofuels to nuclear power to oil extracted by unconventional means from the oil sands of Canada -- to meet soaring demand. The surge in demand is expected to arise from rapid economic growth in such fast-developing countries as China and India, as well as mounting consumption in the U.S., the world's biggest energy market.

This is a good time to look at the daily and weekly oil charts to see how they are performing.

Here's the daily chart. Notice that prices consolidated for about two months between $61 and $67. As a rule of thumb, when prices move within a roughly 10% range, it's usually a consolidation pattern where traders are either selling old positions and taking profits or buying new positions and betting on higher prices. Because oil prices typically increase during the summer, traders were buying contracts in April and May betting on a summer rally.



From the weekly perspective, we have prices bottoming in a classic head and shoulders formation and rallying from that base.



From both a daily and weekly perspective we have a strong reason to expect the rally to continue and for prices to remain high. From the daily perspective we have a solid two month base. From the weekly chart we have a classic reversal.

From the fundamental perspective we have India and China growing at high rates creating an additional 2 billion people demanding energy. Increased demand = higher prices.

In addition, there is the peak oil argument which states oil supplies are already at or near their highest levels and will only decrease from here. I can't speak to the veracity of that claim, but if it's true then we have a big problem on our hands.

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The Last Post

It would seem that the post office workers are determined to drive the final nail into the coffin of Royal Mail, the Times reports that they are gearing up for a series of strikes.

Royal Mail has suffered two national walkouts in the clash over pay and modernisation, and more strike dates are likely to be set tomorrow. The CWU could escalate the action beyond the one-day walkouts that it has called so far, or it may stage a series of regional strikes.

Given that Royal Mail suffers from a lousy reputation re lost letters, outdated working practices, fuddy duddy post offices and stiff competition from the "wired world"/professional delivery companies this strike action is the last thing that it needs.

The customers will simply vote with their feet and walk.

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The Upcoming Week

It's going to be a busy week in the markets.

1.) It's earnings season. 'nuff said.

2.) There are three manufacturing reports. The Empire State survey on Monday, Industrial Production on Tuesday and the Philly on Thursday. Remember that manufacturing/exports are supposed to be a big reason for the US not entering a recession soon, so these numbers are crucial.

3.) PPI is Tuesday and CPI is Wednesday. But remember -- food and energy don't count at all in these numbers.

4.) Housing starts are on Wednesday. Just when the market doesn't need more bad housing news.....

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The Employment Numbers and the Birth/Death Model

There has been a lot of commentary among economists about the effect of the BLS' birth/death model on employment numbers. However, most of these discussions have been annoyingly wonky in my opinion and difficult to understand.

John Mauldin has provided an excellent analysis of exactly what the controversy is and more importantly provides a very readable explanation.

To start with, let's dissect the employment numbers. The official headline number for June was 132,000 new jobs. Since we need about 150,000 new jobs just to stay even with population growth, that is hardly a robust number, but not too far off from what would be a good number. Except that there are some problems with the headline number.

The employment numbers come from a survey of established businesses. But obviously the Bureau of Labor Statistics (BLS) cannot call every business in the US, so they simply survey the larger businesses. But that means they miss the growth in the small-business sector of the economy, which is where the largest amount of new jobs are created.

The BLS surveys about 160,000 businesses in its sample model. There is an unavoidable lag between an establishment opening for business and its appearing on the sample frame and being available for sampling. Because new firm "births" generate a significant portion of employment growth each month, non-sampling methods must be used to estimate this growth. To make up for this, they add or subtract a certain number of jobs, called the birth/death (of new businesses) ratio.

They use the actual births and deaths of real businesses for the last five years to make their estimates of new jobs created from new business. This is quite a legitimate methodology, but it does have one problem. It is backward-looking data. BLS knows that and states the following on its web site:

"The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend. BLS will continue researching alternative model-based techniques for the net birth/death component; it is likely to remain as the most problematic part of the estimation process."

Remember the jobless recovery of the first Bush term and the constant criticism about the poor economy? Why was the economy doing so well and yet job creation was so poor? It turns out that a great deal of the explanation is that the BLS underestimated the number of new jobs being created by small business. In the early years of the recovery, rather badly.

Likewise, the BLS data will overestimate jobs when the economy is slowing down. Is there some evidence that may be the case today? I think there is.

To the credit of the BLS, they are very transparent about their data. There are massive amounts of data available at www.bls.gov and the data on the birth/death ratio is at http://www.bls.gov/web/cesbd.htm. Now, let's examine the contribution of the birth/death ratio to the employment numbers.

Last month, the BLS estimated that there were 156,000 new jobs in the birth/death ratio category, which was 24,000 more jobs than they estimated were created for the month. OK, maybe no problem. Looking back over five years, the economy has created about that many new jobs during the month.

Except that they estimated 26,000 new small-business construction jobs. With home construction dropping, do we really think that the same number of new jobs was created in construction as in June of 2006 and 2005? Or that 153,000 new jobs in small-business construction have been created this year? Really?

In fact, since January, the BLS estimates for the birth/death ratio have added 747,000 new jobs of a total projected growth of 871,000 jobs, or 86% of the total of the jobs estimated supposedly created for the first half of the year.

Is there any other reason to believe that the birth/death ratio may be overstating employment as the economy slows? The always astute Paul Kasriel of Northern Trust thinks there is. He notes that in 2005 the contribution of the birth/death ratio (12-month average) to the overall employment numbers was well under 35%. Today it is over 56%. Given the recent numbers, that ratio is likely to rise.

"What has been happening to the relative contribution of birth/death estimates as the economy has slowed in the past year? The chart below shows that it has been rising. In the 12 months ended March 2006, the birth/death adjustment was contributing only 30.9% of the jobs to the change in nonfarm payrolls. The birth/death relative contribution has been trending higher since then. Notice that as the birth/death contribution to nonfarm payrolls has been trending higher, the percentage of small businesses saying that now is a good time to expand their operations has been trending lower. If existing small business managers do not think now is a good time to expand their operations, does it make sense that there are a lot of new small businesses starting up and hiring?

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Weekend Weimar

The markets are closed. Stop thinking about economics. Go do something else.

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