May 29th

“Preliminary” 1Q09 Gross Domestic Product

Author: Kenn Lamson

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The Commerce Department reported that the “preliminary” estimate of first quarter real Gross Domestic Product fell 5.7%, on an annualized basis, from the fourth quarter of 2008. This level marks a 0.4% upward revision from the “advance” estimate released in late April. The US economy’s growth rate in 4Q08 was -6.3%. Today’s reading was marked by a continued downturn in exports, business investment and housing construction. Positively, consumer spending rose 1.5% in the first quarter. Excluding the effect of inflation, the US economy contracted at a -3.1% annual rate.

As noted above, consumer spending, which represents about 70% of US economic activity, increased by 1.5% after negative readings in the past two quarters. While this rebound could be dismissed as a snap back from unsustainably negative readings, it’s worthy of note that the increase was mostly driven by spending on long-lived (and often more expensive) durable goods.

Unsurprisingly, investment in housing continued to spiral downward, falling 39% on an annualized basis in 1Q09, subtracting 1.39% from GDP. This decline was offset by international trade, which contributed 2.18% to GDP as exports declined less than imports.

A sharp decline in business investment in inventories, which hampers the economy in the short run, is both necessary and beneficial in the longer term, as companies resume a more normal pace of production in coming periods.

As noted, today’s release was the “preliminary” figure that is which includes data unavailable for or corrected from the “advance” number released in April. As with each Commerce Department GDP estimate today’s release is subject to another revision, labeled “final”.

Harmonic Investment Advisors believes that 4Q08 marked the bottom of this economic cycle. However, as noted in earlier commentaries we anticipate that the US economy will remain in recession throughout this year. Consequently our tactical asset allocation, sector weights and security selection remain skewed towards defensive and high quality equities and fixed income investments, although we began earlier this year to tilt our models towards a more neutral position to take advantage of attractive valuations and an economic recovery, albeit one that will likely be slow and fitful.

Real GDP (quarterly data, annualized), white (%) Consumer Spending (quarterly data, annualized), red (%)

Real GDP (quarterly data, annualized), white (%) Consumer Spending (quarterly data, annualized), red (%)

May 26th

S&P / Case-Shiller 20-City Home Price Index – March 2009

Author: Kenn Lamson

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House prices continued their slide in the March, as reported in this morning’s release of the S&P / Case-Shiller Home Price Index. The 20-city Index fell 18.7% from a year earlier, bringing national home prices back to levels seen in the fourth quarter of 2002. All of the cities surveyed for the Index showed year-over-year declines. Prices declined 2.2% from February. Average home prices are down 32.2% from their mid-2006 peak.

However, a number of the cities saw a deceleration in the rate of decline which may suggest an inflection point in the housing market has been reached.

Harmonic Investment Advisors believes home prices are likely to continue to fall as the overhang of unsold homes appears to far outweigh the number of potential buyers. Reports indicate financial institutions may be hoarding properties or forestalling foreclosure to prevent an even larger glut of homes on the market. Further, the pool of potential buyers is negatively impacted by the increased tightening of credit available to fund purchases and by discomfort caused by declining investment market values and rising unemployment. Given that the home is the most valuable asset on most Americans’ personal balance sheet, declines in home prices reinforce the negative sentiment and increase the financial pressure that has contributed to this consumer-led recession.

However, HIA notes that falling home prices have begun to attract some buyers, as suggested by the recently reported increase in sales of existing and new homes. The upside of falling house prices is, of course, greater affordability for buyers, which ultimately will be a factor in slowing and reversing the economic downturn.

S&P / Case-Shiller 20-city Home Price Index (January 2001 – March 2009)

S&P / Case-Shiller 20-city Home Price Index (January 2001 – March 2009)

May 21th

Leading Economic Indicators – April 2009

Author: Kenn Lamson

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The Conference Board its Index of Leading Economic Indicators (LEI) rose 1.0% in April, somewhat better than a consensus expectation for a 0.8% reading and following a -0.2% decline in March. Ken Goldstein, Economist at the Conference Board, stated “The leading indicators suggest that while the recession will continue in the near term, the declines will be less intense. The question is how long before declines in activity give way to small increases. If the indicators continue on the current track, that point might be reached in the second half of the year.”

The LEI rose for the first time in 7 months. Seven components rose, led by stock prices, the interest rate spread (10-year Treasury yield less the Federal Funds rate) and consumer expectations. These items were somewhat offset by negative readings from the other three components, led by the real money supply.

Harmonic Investment Advisors believes that the LEI has historically been a useful tool for forecasting US economic growth. While today’s positive reading reinforces HIA’s expectation of continued economic weakness, the release does apparently corroborate Harmonic’s thesis that the US economy will continue to contract during 2009 but that the rate of contraction will subside in the latter months of the year.

Harmonic will be integrating the information provided in this release into the macroeconomic models that drive its tactical asset allocation and economic sector weightings and expects to shift to an incrementally more cyclical stance as the year progresses and when market valuations appear attractive.

Conference Board Index of Leading Economic Indicators April 2004 – April 2009 (vertical line indicates approximate official start of recession)

Conference Board Index of Leading Economic Indicators April 2004 – April 2009 (vertical line indicates approximate official start of recession)

May 15th

Consumer Price Index – April 2009

Author: Kenn Lamson

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The U.S. Bureau of Labor Statistics reported this morning that the consumer price index (CPI) fell -0.7% from April 2008. Today’s reading is the largest 12-month decline since June 1955. “Core” CPI, which excludes food and energy costs, climbed by 1.9% over the past year. The data indicates that while overall prices have actually fallen, when volatile food and energy costs are excluded the rate falls comfortably within the range the Federal Reserve apparently prefers. This fact reinforces the idea that the ongoing fiscal and monetary stimulus hasn’t ignited inflation. It also suggests that deflation appears unlikely.

Month-over-month, the seasonally-adjusted “headline” CPI was unchanged in April and the monthly “core” rate of consumer inflation rose 0.3%. A 9.3% rise in the cost of tobacco products accounted for almost half of the core index’s increase.

As in earlier months, energy costs remained a dominant driver of consumer prices, with the energy index down 2.4% during April. Housing costs, which comprise 40% of the Index, were down -0.1% during the month.

Harmonic Investment Advisors sees significant benefits resulting from the decline in consumer prices. As suggested by the difference in “headline” and “core” inflation statistics, the decline in prices has primarily been due to declines in energy and food, two of the least discretionary purchases that consumers make. Indeed, as mentioned above the primary contributor to the decline in consumer prices is the dramatic decline in energy prices since oil’s mid-2008 peak. Reduced pressure on consumers supports Harmonic’s stance that while the economy will remain sluggish over the coming months, the strengthening consumer balance sheet, in the form of higher savings, provides a key to stabilization in the economy and stock markets.

Harmonic recently marginally decreased its underweighting to stocks in the consumer discretionary sector in anticipation of improvement in consumer balance sheets, and to take advantage of the attractive valuations of selected high quality stocks in that sector.  For similar reasons, HIA remains overweight stocks in the Integrated Oil sector on the belief that the price of oil is below its fair value and will rise as economic weakness moderates.

Month-over-month (red) and year-over-year (white) “core” CPI (April 2004 – April 2009)

Month-over-month (red) and year-over-year (white) “core” CPI (April 2004 – April 2009)

May 08th

Unemployment Situation – April 2009

Author: Kenn Lamson

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The Labor Department reported that the number of unemployed Americans rose by 539,000 in April, raising the unemployment rate to 8.9%. April’s losses bring the unemployment level to its highest since September 1983. March’s US unemployment rate was 8.5%. Today’s release brings to 5.7 million the total number of lost jobs since the recession began in December 2007, about 2/3 of which have been shed in the past 6 months alone. Today’s figure also represents the smallest loss in six months.

Jobs growth was negative in all major industry groups surveyed except healthcare and government, each of which showed a slight gain.

If workers who were underemployed or who have stopped looking for work are included in the tally the percentage of unemployed plus “marginally attached” workers rose to 15.8%, up from 15.6% in March.

Unfortunately, while the number of unemployed was fewer than expected, this report can’t be characterized as an unvarnished improvement, as much of the improvement came from temporarily-hired government census workers. The report is consistent with the idea that the rate of deterioration is slowing but that the economy is a long way from stabilizing.

While Fed Chairman Bernanke noted in recent testimony that the Fed does not expect that the unemployment rate will reach 10%, Harmonic Investment Advisors believes that unemployment is likely to continue to rise to at least that level. Given that about 70% of US economic activity is driven by the consumer, the negative psychological impact of the fear of losing one’s job and the financial impact of actually doing so will continue the negative spiral of global economic weakness in 2009.

Interestingly, the markets’ behavior since early March suggests that market participants may be beginning to acknowledge the “lagging” nature of unemployment statistics. HIA stands “neutral” on stocks of businesses dependent on consumer spending, having moved from an “underweight” position in February. We continue to search for high quality firms that will be survivors of the downturn and that are trading at very depressed valuations in anticipation of increasing the cyclical bias of our strategies later this year.

US Unemployment Rate (white, left scale) Nonfarm Payrolls, monthly change (red, right scale) (December 1999 – April 2009)

US Unemployment Rate (white, left scale) Nonfarm Payrolls, monthly change (red, right scale) (December 1999 – April 2009)