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How Long Until Higher Prices Hit Consumers?


Consumer confidence slipped in February according to the latest surveys. The Consumer Confidence Index from the Conference Board dropped 1.1 points to 104, but was a point higher than economists expected. The weakness was attributed to consumer's diminished perceptions for the next six-months. The present situation index actually rose 4.2 point so 116.4 and is at the highest level since September 2001. While consumers have been gradually feeling better about the present situation since the fall of 2003, expectations have remained muted. An improving labor market has contributed to the increase of confidence. The percent of respondents that felt jobs were hard to get fell 1.3 percentage points to 22.6, the lowest level since May 2002. It has dropped by 6.3 percentage points over the past year, while the percent that view the employment plentiful has gained 6.4 percentage points. Also contributing to the increase in confidence was the drop in the number of respondents that thought business conditions were bad. It dropped 2.5 points to 15.6, the lowest since August 2001. While consumers generally don't feel conditions were bad in February, they do not see conditions improving over the next six months either. The percent that thought conditions would improve dropped 4.2 points to 17.8, which was the lowest reading since March 2003, right before the Iraq war.

The University of Michigan Consumer Sentiment Survey dropped 1.3 points in February to 94.2. Similar to the Conference Board's survey there was a drop in the expectations component. It dropped 2.3 points to 83.4, the lowest level since April last year, While to current sentiment is at four-year highs. But all this may be moot. Dean Croushore, economics professor at University of Richmond and former Federal Reserve Vice-President, recently published a study that found neither of these surveys were a good predictor of future consumer spending. It is interesting because he initially set out to prove that they offered more insight than economists were crediting them for. But he concluded that "forecasters can ignore consumer-confidence indexes in forecasting consumption spending."

Last week, The Bureau of Labor Statistics reported that producer prices rose 0.3% in January from the previous month and were 4.2% higher than a year ago. The real shocker was the 0.8% month-over-month gain excluding food and energy. That was the largest monthly increase since December 1998. Prices for intermediate materials have been rising more rapidly since last March, up 7% compared to an increase of 3.7% for finished goods. Excluding food and energy, intermediate materials were up 8.5% from last year. This was the largest year-over-year increase since 1981. This corroborates what we have discussed throughout earnings season. Over the past several weeks, several of the producers of raw materials said that their input prices rose and are starting to pass along those price increases to their customers. On Wednesday, Masco, the manufacturer of building products such as Delta faucets, said earnings for the first quarter will be$0.44 to $0.47 per share compared to analysts' estimates of $0.52 per share due to higher raw material costs. The company also said that it "is implementing additional selling price increases on a number of its products, and believes that by the end of the second quarter, many of these commodity cost increases will be largely offset." Additionally, the company expects housing starts to decline by 5% in 2005.

As these companies continue to raise prices, consumers will pay higher prices. Whether or not the government's calculation of consumer prices will capture these higher prices is another question. On Wednesday, the Bureau of Labor Statistics reported that consumer prices rose only 3.0% from a year ago. This was below the 3.2% increase economists expected and the slowest pace since September. Perhaps the most debatable calculation in the CPI is for housing. While the BLS reported that the price of housing increased 3% from last year, and "owners equivalent rent" increased only 2.3%. On Wednesday, Bloomberg had a story discussing Manhattan real estate. It said that Manhattan real estate has increased 223% over the past decade. It also said that the median price for a single-family home in the US rose 67% over the past ten years. This is quite a bit higher than the 35.5% increase in the owners equivalent rent data series that is used to calculate the CPI. Bloomberg has the owners equivalent rent data back to December 1982. The eighteen years up to December 2000, owner's equivalent rent increased 102%. This compares to a 106% increase in the median priced home as reported by the National Association of Realtors. This is surprisingly similar, especially since from December 2000 until December 2004 the difference is quite dramatic. According to the BLS, housing increased by 12.6%. According the National Association of Realtors, housing prices rose 35.2%, almost three times as much.

About 90% of the S&P 500 have reported fourth quarter earnings. First Call expects earnings growth of 20.4%. Perhaps another sign of inflationary pressure is that revenues have increased by 13.1% over last year as well. This is the fifth consecutive quarter of double-digit revenue growth. First quarter earnings estimates are not faring as well. While overall S&P 500 earnings growth estimates have increased this month from 6.3% to 7.1%, the entire increase is due to higher expectations for energy companies. Energy companies are now expected to post earnings growth of 28% during the first quarter compared to 18% on February 1. Consumer discretionary earning have had the largest negative revision since the quarter started. Earnings growth estimates have fallen from an increase of 5% on January 1 to a decline of 5%.

Earnings growth is expected to be 9.7% for the full year, down from 10.5% at the beginning of the year. Seven of the S&P 500 groups have experienced a decline in growth estimates. Only the energy sector has had estimates raised for the full year. Earnings growth is clearly decelerating from the torrid pace over the past five quarters. Slowing earnings growth coupled with higher interest rates will likely pressure equity valuations.

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