UNEDITED

It seems everyone is focused on employment. It is the driving political football and the markets are fixated on any clues that offer insight to when the "jobless recovery" changes into a "jobs recovery." Everyone's focus this week is on the February employment report from the Department of Labor. On Monday, the market rallied after the ISM survey showed that its employment component rose to the highest level since December 1987. Unfortunately, the same cannot be said about the survey covering the non-manufacturing side of the economy. The employment index from the ISM non-manufacturing survey dropped 0.7 points to 52.7. While respondents do anticipate increasing their payrolls, the index has dropped for the third consecutive month.

Overall, with both surveys over 60, purchasing managers are upbeat concerning the economy. Commenting on the strength of the manufacturing survey, Norbert J. Ore, C.P.M., chair of the Institute for Supply Management said, "All 20 manufacturing industries reported growth. New Orders and Production both decelerated this month, but they are still at very positive levels." While much of the focus was on the employment component, the prices index had the largest gain. The prices index rose 6 points to 81.5, which was the highest level since February 1995. Sixty-five percent of respondents reported paying higher prices, almost twice the percent that did just three months ago. The lists below are from the ISM report and detail the status of several commodities as reported by its members.

"Electronic Components; Stainless Steel; Steel; Steel, Hot Rolled; Steel, Cold Rolled, and Steel sheet are the commodities in short supply. Commodities reported up in price are: Acetone, Aluminum; Aluminum Extrusions; Brass and Brass Products; Chemicals; Coal; Copper and Copper Products; Corrugated; Electrical Components; Energy; Ethylene; Ethylene Oxide; Fuel Oil; Gasoline; HDPE Products; Lumber; Metals; Natural Gas; Nickel; Particle Board; Plastics; Polyethylene; Polyethylene Resin; Polypropylene; Propylene; Pulp; Resin; Stainless Steel; Steel; Steel, Cold Rolled; Steel, Flat Rolled; Steel, Hot Rolled; Steel Pipe; Steel Sheet; and Steel Scrap. The commodities reported down in price are Caustic Soda; Corrugated Cartons; Natural Gas; and Packaging Materials. Natural Gas was listed as both up and down in price," Ore stated.

These diffusion indexes that measure the economy can be difficult to fully comprehend. The latest survey from the Institute of Supply Management highlights this difficulty. The new orders component of the index fell 4.7 points to 66.4. This does not mean that the manufacturing sector received fewer orders in February than in January. Rather, it shows the pace of growth slowed in February compared to January. As long as the index is above 50 there is expansion. Below is the table showing the responses for the new orders component.

As the table shows, more purchasing managers reported an increase in new orders while fewer reported that new orders were worse in February. However, the rate of increase was slower than from December to January so the index declined. Since several of these indexes have been at multi-year highs recently, it will be important to realize how these indexes measure economic activity and future declines will not necessarily equate to a contracting economy.

The Federal Reserve's Beige Book was published on Wednesday. To little surprise it said that, "Economic activity continued to expand in January and February, according to information received by Federal Reserve District Banks." Furthermore, consumer spending grew in all but the St. Louis district, but all but two districts reported that vehicle sales were slow.

The automakers released February sales this week, which came in at 16.4 million unit rate. This was 5% better than last year's depressed levels but was under economists' expectations for the second month in a row. We have expressed concern over the past several years that auto sales were being buoyed by easy financing terms that is causing long-term damage to the industry. Our thanks go to Grant's Interest Rate Observer for pointing out an article in Automotive News dated February 16, 2004. The article highlighted the "upside down" nature of current auto buyers. According to Edmunds.com, 30% of car buyers were upside down in 2003, up from 24% in 2002. Moreover, on average, car buyers are rolling over $3,700 of debt from their previous vehicle into the loan for their new car. This is almost twice the level from 2000. In fact, for the first time ever buyers are financing more than the invoice price of the car. According to the Consumer Bankers Association, consumers financed 100.9% of the invoice price compared to 89% just six years ago. This will cause more drivers to be upside down for years to come. Not only are down payments virtually non-existent, the maturity of loans keeps lengthening. Edmunds.com also reported that over the past decade down payments have dropped from 15% to 5% and article mentioned Morgan Stanley's auto analysts said that the average new car loan is over 63 month compared to 55 months in 2001. Additionally, more than 20% of buyers are selecting 72-month loans.

The article also offered a few examples of what is happening in the dealership financing office. A local Chevrolet dealer did a 96-month loan for a Suburban. The buyer financed $46,911, which was $18,136 more than the invoice price. Several dealers spoke with candor. One dealer in Killeen, Texas, said, "As long as one guy is doing it, in order to compete I have to do it, too. It's terrible for the consumer, but it would be unwise not to compete in the marketplace. And the consumer only cares about the deal you're going to give him." Another in Ohio said, "The customer comes back in and you're trying to bail him out, and they are so far into negative equity you just keep tacking it on. We're not helping them out because they never get out of it."

This week, the Department of Commerce reported that personal income rose 0.2% on a month-over-month basis in January. This was lower than the 0.4% increase economists were expecting and was the lowest increase since August last year. On a year-over-year basis personal income is up a healthy 4.1%. On a year-over-year basis, growth in personal income has been steadily increasing since it bottomed in early 2002 at about 1.5%. The increase in spending was more robust. January spending increased 0.4% from December and up 5.3% from a year ago. Since April 2001, year-over-year increase in spending has grown faster than income every month. This is the continuance of a trend that started several decades ago.

Over the past four decades, the increase in spending has eclipsed the increase in personal income. The table below tracks the average monthly difference between the year-over-year change in personal income versus the year-over-year change in spending.

This shows that during the 1960's the year-over-year increase in personal income was 0.41% higher than the increase in spending. This has flipped and so far during this decade the year-over-year increase in spending has outstripped the increase in personal income by 120 basis points. This trend has benefited the economy as consumers have increased the amount they spend. There must, however, be a point where consumers cannot simply spend on command.

From the mid-1980's, there has been a constant decline in the personal savings rate. This has benefited the economy as consumers increased the amount of personal income that went toward consumption. The savings rate dropped below 3% for the first time in April 1999. Since then, it has hovered around 2%, dropping below 1% twice and above 3% three times. At this point it was virtually impossible to save any less. Then in 2001, the housing and refinance boom that started and allowed consumers to further increase spending above income growth. With personal income increasing at the highest level since early 2001 and home prices continuing to escalate, consumers do not see the necessity to reign in spending. For consumers to stop spending, the financiers will have to turn off the credit spigot. Right now, with the advent of "Pay Option ARMS" and $46,000 Suburban loans, the financiers have simply ripped off the valve and anyone that walks in front of the spigot just has to hold his pockets open. At some point this will change. I wish I knew if these tactics were the last grasp or if financing terms are going to get more lenient. I wonder if the mortgage industry will take a page from the consumer retail industry and offer "no payment, no interest for one-year."