Philadelphia Feeling: Federal Reserve Bank of Philadelphia Business Outlook Survey March 2008

Today, the Federal Reserve Bank of Philadelphia released the results of their Business Outlook Survey for March showing some moderation in the recent weakness seen in the regions manufacturing sector.

The survey of the Philadelphia regions manufacturing sector has been a pretty solid leading indicator of the overall strength or weakness and recession experienced by general economy.

As you can see by the following chart (click for larger version), during the past three post-recession expansion periods, the “current” diffusion index generally vacillated between 0 and 35 while the “future” index left the period of contraction at an elevated level and eventually joining the “current” index.

Finally, as the economy pushes closer to contraction, both indices decline dramatically with a breach of -20 by the “current” index generally indicating that recession is upon us.


As you can see from last month’s results, -20 has been breached by the “current” index which now stands at -17.40 while the “future” index stands at -0.5.

Clearly, there is trouble afoot but components of the latest results also display a potential dangerous parallel to the stagflationary eras of the 70s and early 80s.

The following chart shows the latest results of the “current new orders” “current prices paid” and “future employment” components (click for larger versions).

Notice that while current orders and future employment declined, current prices paid have increased indicating a potential return to a stagflationary environment that hasn’t been seen since the early 80s.

It’s important to note that these three indicators have moved, more or less, together since the expansion of 1983 and have especially moved together during the recessionary periods of 1990 and 2001.

Now though, it appears that we may be seeing a divergence with an increase in prices paid and simultaneous decrease in growth.

The following chart (click for larger) shows these measures during the last stagflationary era seen between 1976 – 1980. Notice the clear divergence of rising prices and falling growth.

Conspicuous Correlation: November 2007

In light of yesterday’s results for Producer Prices, and Retail Sales and Today’s results for Consumer Prices, I’m reworking my analysis of the possible correlation between falling home values and declining consumption of the most “discretionary” retail items.

On a “nominal” basis, there appeared to be “rough correlation” between strong home value appreciation and strong retail spending preceding the housing bust and an even stronger correlation when home values started to decline.

The following charts show the initial analysis plotting the year-over-year change to an aggregate series consisting of the primary discretionary retail sales categories that I termed the “discretionary” retail sales series and the year-over-year change to the S&P/Case-Shiller Composite home price index since 1993 and since 2000.


As you can see there was, at the very least, a coincidental change to home values and consumer spending during the boom and then the bust, but as home values have continued to decline, retail spending has remained low but has not continued to consistently contract.

One problem with this initial analysis is that both retail sales and the S&P/Case-Shiller Composite index are reported in “nominal” (i.e. non-inflation adjusted) terms and thus result in a somewhat skewed view especially for the retail sales data.

In fact, the year-over-year change to “nominal” discretionary retail sales has been positive for the last seven months while the year-over-year change to “real” discretionary retail sales has been negative for twelve straight months (see the following chart).

The key point here is that although inflation (as reported by the CPI) has been relatively stable in recent years it is always a factor and in light of the latest surprise increases to the PPI and CPI results as well as many anecdotal reports of producers now passing through increasing energy prices to the consumer, it’s important to adjust retail sales (and home values) in order to fully understand its direction.


As you can see from the above charts (click for larger version), adjusted for inflation (CPI for retail sales, CPI less shelter for S&P/Case-Shiller Composite) the “rough correlation” between the year-over-year change to the “discretionary” retail sales series and the year-over-year S&P/Case-Shiller Composite series seems now even more significant.

Given the anecdotal accounts of homeowners drawing equity out of their homes with refi’s and HELOCs and using the proceeds to buy consumer goods, it could be interesting to attempt to “shift” the retail spending in time as the decline to home values would surely precede a pullback in consumer spending but for now I’ll leave it aligned and work on the shifting in a later post.

To make the analysis even a bit more formal (at the prompting of reader Deejayoh) I also plotted the year-over-year changes an overlaid a 12 month moving Pearson’s correlation in order to see the “exact” correlation between the two data series (click for larger chart).

As you can see, although there was a significant correlation of the declines of these series starting in August 2006, this relationship has been falling away as real home values consistently contract and real retail sales remain negative but not falling as consistently.

This is probably a reasonable conclusion as expecting perfectly correlated changes in home values and consumer spending seems unlikely BUT it is probably important to note that home values and the level of consumer spending on discretionary items are in fact both consistently contracting.

Defining Inflation: CPI October 2007

In an effort to gain a little better perspective on the historic, current and more importantly future direction of inflation, I’m adding coverage of the monthly CPI data to the lineup of regularly occurring posts.

I’ll continue to develop the analysis adding other housing and economic related data in future posts but for now, let’s just get a sense of how well inflation is measured and read.

I think it’s safe to say that the notion of inflation being moderate and contained is a widely held belief.

But is it entirely accurate?

Although there is a clear difference between today’s circumstances and that of the troubling inflationary eras of the 70s and early 80s, consumer households still appear to be facing some pretty significant rising price pressures.

We are all aware of the fact that gasoline is priced considerably higher now than just three years ago but what about other essential consumer goods and services?

The following chart (click for larger version) shows indices for Food and Beverage, Apparel, Gasoline, Medical, Education, Owners’ Equivalent Rent, Household Fuel, CPI Core and for sanity’s sake, the Case-Shiller Composite index since 1997 all normalized to a base of 100.

First, notice that the black “dotted” line is the CPI Core index, which is simply the CPI minus food and fuel.

If you were to dwell mostly on CPI core, as the Fed does when evaluating future expectations, inflation does look moderate.

But, notice that, excluding the Case-Shiller index for a moment, Gasoline, Household Fuel, Education and Medical prices have increased (and are continuing to increase) fairly significantly.

This seems to fit well for our general knowledge of both the obvious increase in oil costs and the widely reported increasing prices for medical goods and services and of college room, board and tuition.

Next, notice that Owners’ Equivalent Rent, the price index that the government uses to represent housing in the CPI, looks unusually stable and seems to understate increases to housing prices when compared to the more realistic and accurate S&P/Case-Shiller home price index.

Lastly, notice that Food and Beverage prices recently appear to be tipping up a bit, likely as a result of the prolonged increase in fuel prices leaving only Apparel to be considered a truly moderate (and even falling) essential consumer cost.