It appears that the economy has started to recover and the recession is almost a distant memory. Retail sales in April were up a strong 1.2% and industrial production increased for the fourth consecutive month. Unfortunately, these gains have been more influenced by consumers reacting to various stimulus including record refinancings, record auto incentives and record tax refunds. As this stimulus begins to wane, it will be difficult for consumers to continue to shoulder the economic rebound. As previously discussed, it remains unlikely that companies will increase capital spending to lead the economy to recovery.

Tuesday's report on retail sales, up 1.2%, surprised economists who were expecting retail sales to increase 0.7%. Excluding autos, retail sales jumped 1% versus the 0.5% economists expected. Besides autos, building materials, health and personal care and gasoline stations were the strongest categories, while furniture, food and beverage, and sporting goods were laggards. Investors rallied stocks on the stronger than expected retail sales while economists were surprised by the magnitude of the increase. Granted, April's retail sales were the strongest since October, but it is hardly surprising. Consumers have continued to defy economists calling for the slowdown. Consumers still have cash from the record amount of refinancing activity from last year and a record amount of tax refunds. Going forward these stimuli will diminish. Refinancing activity was beginning to pick up again, but a rise in interest rates last week already slowed down activity. Tuesday's raise in interest rates following the retail sales data will likely curb refinancing activity further.

I've regularly used a basket of retailing companies to gauge the health of consumers instead of looking at the seasonally adjusted month-to-month change in retail sales that the government publishes. This basket of 26 retailers posted year-over-years sales growth of 7.0% in April. While April sales growth was sharply down from the 11.8% and 10.9% sales growth posted in March and February respectively, the Easter holiday pulled forward some sales into March. Combining March and April sales, to mitigate the Easter effect, shows a very strong 9.5% increase over last year. Retail sales in the coming months will be important. It should give an indication the strength of consumers without the benefit of various stimulus that have been providing a strong tailwind.

Industrial production in April increased slightly and appears to have formed a bottom at these levels. It is important to remember that production levels remain below year ago levels. April's production of $139.2 billion was 2% lower than last year and is at levels similar to mid-1999. Companies have continued to pare down inventory with the inventory-to-sales ratio falling to at least ten year lows. Companies are obviously maintaining a wait-and-see attitude regarding the pending recovery before starting to restock inventory. Industrial capacity utilization increased slightly last month to 75.5%, increased auto production amounted to two-thirds of the increase. The slight increase in utilization is not enough for companies to start upgrading equipment and spending on additional facilities.

Retail sales have benefited from consumers being flush with cash from refinancings, and tax refunds. Industrial production is getting a huge boost from auto sales that are being stimulated by historic incentives. This record bout of stimulus should start abating in the next couple months. There is evidence that lenders were too lax in their lending approvals. Credit card delinquencies increased in the first quarter to 5.4% from 5.2% last year. Even more alarming, the amount of bad debt written off rose to an annualized 6.4%, the highest since the second quarter of 1998.

Surprisingly, Dallas Fed president, Robert McTeer, indicated that the economic recovery has moderated. Speaking at the Dallas Rotary Club, McTeer said, "The statistics have been positive, but not as strong as the months before, so I don't mean to suggest that the recovery is in some sort of jeopardy; but certainly its momentum has diminished." He also indicated that interest rates hikes are unlikely in the near-term since "we have a pretty good record on inflation" and continuing productivity growth which will allow the economy to accelerate more without inflationary pressures. What else would we expect!

Another factor that will likely cause consumers to cutback on discretionary spending is the increasing cost of insurance. Health insurance costs have been driving up labor cost and putting a crimp in workers budgets as individuals have been force to shoulder more of the costs. Now homeowners are experiencing hefty premium increases. As an industry, homeowners' insurance racked up losses of over $8 billion last year, more than double the amount last year. The combination between escalating claims and investment losses is causing insurance companies to increase premiums or cease renewing policies that have multiple claims. During the first quarter, Allstate has won regulatory approval to increase premiums in 23 states. The average increase is almost 20%. Here in Texas, due the black mold claims, homeowners rates have more than doubled in some areas. Mine personally increased more than 40%. State Farm said it will stop writing new homeowners policies in California, and increased rates in Hawaii for the first time in 10 years.

The California housing bubble might be starting to show signs of abating. A recent article in the San Francisco Chronicle indicates that apartment vacancies are rising and rents are falling. According to Keith Carroll, owner of Castle Rock Realty, which manages about 400 residential units, says, "In 22 years of doing this, this is probably one of the highest vacancy rates I've seen." Rents in San Francisco have fallen by 15% over the past year. San Jose has experienced a larger 25% fall for the average one-bed room, one-bathroom apartment. Landlords are even offering incentives. "Pets negotiable, free utilities, free cable, one free month's rent. I've never seen that before," said Davin Wong, president of eHousing. Rentals are having a tough time as renters are deciding to buy a house instead. The residential housing market is starting to look like to boom times of the late 1990s with houses getting multiple offers. It is too early to call the top in California real estate, but this development could be the first sign that real estate is peaking.

Consumers have been able to make the recession relatively mild thus far by taking advantage of low interest rates and lax lending standards. While this enabled the economy to grow the past two quarters, it will be difficult for consumers to continue to increase their spending as the extra cash put in consumers' pockets runs out.