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Another Twenty-Five Basis Points


Surprising nobody, the Federal Reserve increased the fed funds target rate by 25 basis points to 2.25%. This was the fifth consecutive rate hike. While the Fed still said that rates were "accommodative," economists are staring to debate whether there will be another rate hike and when it will happen. David Rosenberg, chief North American economist for Merrill Lynch, thinks the Fed will stop raising rates. On the other end of the spectrum is Barclays Capital Corp's head of economics, Larry Kantor. Kantor thinks that the target rate will be 4.0% by the end of 2005 and eventually touch 6% or higher.

Several regional Federal Reserve surveys were released this week that showed mixed results. The Kansas City survey showed that business activity increased in November. The increase was led by an increase in the number of workers. The number of employees' component rose three points to a nine-year high, however the average workweek declined. Prices paid for raw materials remained high and is higher than prices received for finished goods. Looking ahead six-months, managers expect business conditions to remain robust. Additionally, more managers expect prices for raw materials to increase more than the prices they receive for finished goods. The Richmond Fed survey showed a decline in business activity for the first time since September 2003. Of the twelve components, nine declined and five were negative. Similar to the Kansas City survey, managers in the Richmond district also see prices rising faster for inputs than for finished goods. Prices received have increased this year and have increased by 1.76% from a year ago. It also appears companies will be able to pass along price increases in the future. Over the next six-months managers expect to be able to raise prices by 2.16% compared to only 0.08% in the September survey. Prices paid are still expected to be higher, but the differential is diminishing.

The Empire State survey was released on Wednesday. This survey provides one of the first looks at December, The survey revealed a very conflicted view of the economy. On one hand, nine of the ten components increased, but ten of the twelve components the monitor expectations for the next six-months declined. New orders jumped 23.2 points to 40.15, a new high. Prices paid increased 4.36 points to 57.69, which was the second highest reading since the survey started in mid-2001. While the general business conditions top-line number rose eleven points, the view six-months out showed much less confidence. In fact, it dropped 6.1 points to 47.76, which was the lowest reading since April 2003. The outlook for new orders fell almost 10.5 points to 47.76, the lowest since March 2003. Prices are expected to rise further. Expectations for price in six-months jumped 6.67 points to 62.5, the highest in the surveys short history.

The November producer price index increased 5.0% compared to last November. This was much higher than the 4.4% increase economists forecasted and was the largest increase in producer prices since December 1990. The largest year-over-year increases were in fuels (28.9%), chemicals (12.5%) and metals (20.5%).

Along with the Federal Reserve surveys, the latest Manpower survey showed that the employment outlook is the best since early 2001. The mining sector has the best outlook in over 25 years and financial services since late 1980's.

Year-over-year retail sales excluding autos grew 8.6% in November. During nine of the eleven months this year, retail sales have increased by more than 8% from the prior year. Auto sales actually had the best month since March, up 7.6% year-over-year. Building materials also posted the strongest growth since March. Furniture sales were the strongest in four months. The high price of gasoline helped gas stations increase sales by 25.9% from last November. General merchandise lagged, up only 4.6%, but internet sales jumped 18.1%. Internet retailers might be taking a big bite out of brick & mortar retailers. Amazon reported that it has sold-out of several models of Apple's iPods.

Chain store sales growth dropped to 2.4% on a year-over-year basis last week. This matched the increase during Thanksgiving week, which was the slowest since September 10. This weekend is the last weekend before Christmas, which has been the strongest week for holiday shopping over the past several years, but it will take a very strong week for this holiday season to match the 3.5% to 4.5% gain forecasted by the International Council of Shopping Centers.

Best Buy reported third quarter earnings this week that were one penny better than Wall Street forecasted. While same store sales were up only 3.2%, the company said it expects fourth quarter comps to be +3% to +5 % and said same store sales were in this range during the first two weeks of the quarter. The company noted that a "slightly more promotional environment" caused margins to contract 10 basis points to 25.5%.

One of the hottest sectors continues to be the housing sector. On Wednesday, Lennar reported earnings per share that were eight cents higher than estimates and 35% higher than last year. Lennar said that its cancellation rate was below its normal 20%-30% range during the fourth quarter. Revenue jumped 21%, helped by a 12% increase in the average price of homes. The higher priced homes also contributed to gross margins expanding by 190 basis points to 25.6%. TOL. Not surprising, homebuilders remained optimistic in November. The NABH index ticked up one point to 71. This is the highest level of optimism since 1999. Speaking of 1999, Las Vegas Sands went public today. Originally, the expected price was going to be between $20 and $22. Then it was boosted to $24 to $26 last Friday. It ended up being priced at $29 and closing its first day of trading at $46.56. Its two casinos are valued over $17 billion.

The domestic automotive industry is clearly lagging most other industries. Last week, Delphi, the largest auto parts supplier, revised its outlook for the rest of 2004 and 2005. Instead of earning $0.07 per share in the fourth quarter, it expects to lose between $0.12 and $0.16 per share. The losses are expected to continue into next year. Analysts were forecasting the company to be profitable by $0.59 per share. The company now expects to miss this by a considerable margin. It guided to a loss of $0.35 per share. The company cited a global slowdown in automotive production, soaring raw material costs, and union employees that are not retiring fast enough.

I will be taking the next two weeks off. There will not be a mid-week commentary until January 5, 2005. I wish everyone a joyful and safe holiday.

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