Beige Book Brighter - Analyst Blog

The Federal Reserve released its Beige Book, a collection of mostly anectdotal information from the 12 Federal Reserve Districts across the country.  Below are some of the key passages from the report and my reactions to them.
 
"Reports from the twelve Federal Reserve Districts indicate that economic conditions have generally improved modestly since the last report. Eight Districts indicated some pickup in activity or improvement in conditions, while the remaining four -- Philadelphia, Cleveland, Richmond, and Atlanta -- reported that conditions were little changed and/or mixed."
 
Two-thirds of the country are seeing things get better. The remaining third is seeing conditions stay stable (at a lousy level).  The good news is that there are no areas seeing further deterioration.

"Consumer spending was reported to have picked up moderately since the last report, for both general merchandise and vehicles; a number of Districts noted relatively robust sales of used autos. Most Districts indicated that non-auto retailers were holding lean inventories going into the holiday season.

"Tourism activity varied across Districts. Manufacturing conditions were said to be, on balance, steady to moderately improving across most of the country, while conditions in the nonfinancial service sector generally strengthened somewhat, though with some variation across Districts and across industries."
 
New car sales came in OK for November -- actually up slightly from year-ago levels -- and aside from the "Cash for Clunkers" (C4C)-induced surge in August, the only year-over-year increase in the last two years, as shown in the graph below (from http://www.econbrowser.com/archives/2009/12/anemic_recovery.html). Note that the numbers shown are not seasonally adjusted. On a seasonally adjusted basis, sales were 10.93 million in November, which aside from the C4C influenced July and August, the best since September of 2008.

This is a good sign, although there is no way we are going back to the over-17-million rates that were common just a few years ago. Ford (F) in particular has done a good job stabilizing its sales and in the process, growing market share. Lean inventories mean that for most retailers this will be a profitable holiday season, even if slaes are only roughly flat with a year ago. The anecdotal evidence collected by the Fed seems to coraborate the slow-but-steady recovery in manufacturing seen in the ISM survey released yesterday.
 

 
"Residential real estate conditions were somewhat improved from very low levels, on balance, led by the lower end of the market. Most Districts reported some pickup in home sales, though prices were generally said to be flat or declining modestly; residential construction was characterized as weak, but some Districts did note some pickup in activity. Commercial real estate markets and construction activity were depicted as very weak and, in many cases, deteriorating."
 
While in the short term a pick-up in residential real estate is a very good thing for the economy, we still have too many empty houses in this country. Building more of them does not make a lot of sense, although at the local level there might be areas where new houses are needed. An empty house in Detroit or Dayton is not a good substitute for a house in Dallas or Denver.

Housing prices for both new and used homes are important since as housing prices decline, more people are thrust underwater on their mortgages are thus become more likely to default. Also, housing is the largest asset for the vast majority of people.

Commercial real estate started its decline long after the decline in residential real estate. Every major area of commercial real estate (CRE) is seeing higher vacancy rates, lower rents and rising cap rates. As a result, Moody's (MCO) recently estimated that nationwide commercial real estate values are down 43% from their peak.

Most CRE is financed on short-term mortgages, usually five years, and banks are going to be reluctant to roll over mortgages when the value of the collateral is far below the amount of the mortgage. After all, owners of CRE are far less shy about walking away and handing over the keys to the bank than are underwater homeowners. This is a good reason to avoid REITs like Simon Property Group (SPG) and Duke Realty (DRE).

"Financial institutions generally reported steady-to-weaker loan demand, continued tight credit standards and steady or deteriorating loan quality. In the agricultural sector, the fall harvest was delayed in the eastern half of the nation due to excessively wet conditions during October and early November.

Most energy-producing Districts noted a slight uptick in activity in the sector since the last report. Labor market conditions remained weak since the last report, though there were signs of stabilization and scattered signs of improvement. While some Districts reported upward pressure on commodity prices, they saw little or no indication of upward wage pressures or of any significant increase in prices of finished goods."

Job one for the Fed has to be getting the unemployment rate down -- inflation simply is not a problem right now. This means keeping short-term rates very low, negative in real terms. This in turn will be good for commodities, especially gold, which is very sensitive to real interest rates, rising when they are negative and falling when they are very positive. While the rate of decline in the labor markets has slowed dramatically over the course of the last year, it has not been reversed, and even when it does reverse there will be a lot of ground to make up. 
 
All in all this is a more postive Beige Book than the last one, which was in turn more positive than the one before that. The recovery is happening, although not at the sort of pace that I (or most people) would like to see. The damage inflicted on the economy last year (or, to be more precise, that came to a head last fall -- the actual damage was being inflicted on the economy for years before then) is simply too great to produce the sort of robust recovery that usually happens after a sharp downturn.  

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.
Read the full analyst report on "F"
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