Thursday, October 26, 2006

Solving the Puzzle of the Economic Data

For the third consecutive meeting the Federal Reserve held interest rates steady, after having previously raised rates 17 consecutive times. Experts are debating where the Fed will go next, while generally agreeing no changes are expected in the immediate future. That’s about as close to “we have no idea what’s going to happen next” as you will ever hear from experts.

Let’s go through some of the numbers and see if we can at least do a little better.


New data was just released on durable-goods orders, one of the best indicators of how the industrial economy is doing. Economists had projected a rise of 2.3% for September, and the market rallied a bit when the number came out at a thundering 7.8% increase in orders for durable goods! This looks great until you realize that subtracting out transportation leaves you with an order increase of only 0.1%. This follows an August report which was actually a decline of 0.1%. The September gain was almost completely due to a 42% increase in defense capital orders.

Durable goods orders are a “leading” indicator (not as in the best, but as in one that happens ahead of the trend it’s predicting) of the economy and often a coincident indicator of the stock market. What we see then is a cresting of durable goods orders. If we predict that defense spending is going to decline next year (which I will, given how unpopular the war in Iraq is) it looks like durable goods orders will probably decline in the future, typically indicating a market decline as well.


As recently as yesterday the ever-optimistic National Association of Realtors pundits were saying that the market was not seeing significant drops, despite a 1.9% decline in existing homes sales. Today’s new home sales report showed a September increase of 5.3% in sales, but it also revealed a stunning 9.7% sales price drop in the last month, the biggest since 1970. Ian Shepherdson, chief economist with High Frequency Economics, described the falloff in prices as startling. "Pressure on prices is, therefore, still down, and falling prices deter buyers," he said.

Accelerating sales with strongly dropping prices has another name: selloff! New homes are being drastically reduced in price by builders who see worse days coming, this despite low mortgage rates by historic standards. New building permits, another leading indicator, are also down significantly.


After the release of economic data Treasury Bond Prices have been rising (driving down rates), suggesting a fair number of people are buying bonds to insulate themselves against a downturn. I don’t think we have to move right away as market tops tend to wobble along for at least a few months, but a change in market tone may be near.


Remember all that debate about the direction of the Federal Reserve rate? It may interest you to know that in the history of the modern Fed it has never gone back to raising after a pause in hikes. By the time the Fed stops, it has generally sown the seeds of a future slowdown, it’s just a matter of time.

As per my recent post I have sold covered calls on the Dow Industrial index. I will continue to analyze and post on recommended strategies and directions, and I invite you to comment or contact me via the email link to the right.

Invest Well,


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