September 2012

With economic activity continuing to grow at a low single-digit pace, the Presidential race still too close to call, and the “fiscal cliff” looming, fixed income investor demand for safety continued in September. The flight to safety is most evident in the demand for 3-month U.S. Treasury Bills, which closed the month with a yield-to-maturity below 0.00%.

As we’ve detailed for several months, business confidence has been shaken by the prospect of the fiscal cliff, and the potential damage it’s feared to inflict on economic activity. The monthly survey of manufacturing purchasing managers, an indicator of manufacturing activity, has fallen from levels reached earlier this year. While there is a strong correlation between the index and actual activity, the purchasing managers’ survey can be volatile and misleading at times. As such, we’ve been watching for slowing economic activity to confirm the fall in the index. We began to witness confirmation on several fronts in September. Early in the month, FedEx announced that global shipping had slowed noticeably and informed analysts that earnings per share for the coming quarter would likely fall 10% below previously communicated estimates. Further confirmation of the slowdown in shipping came days later when Norfolk Southern Railroad guided profit expectation sharply lower, albeit for a slightly different reason. While intermodal shipping, the transportation of manufactured goods, slowed from year ago levels, revenue at the rail company also suffered from the dual economic drag of the drought and the collapse in natural gas prices. With the drought, farmers are shipping fewer crops, while the drop in natural gas makes switching from coal to natural gas economically beneficial to those utilities capable of doing so. Both have a detrimental impact on carloads. Also of note, 3M Co. announced mid-month that given the slowing in global growth, management expects organic growth to register in the single digits. Management went on to say that to augment that growth, they expect to make a significant acquisition in the near future. While hardly a precursor to a disappointing earnings season, the preannouncements have caused us to temper our expectations.

In spite of the slowdown in manufacturing there were a number of positive indicators during the month. Probably most surprising was the continued improvement in the housing sector. Existing home sales were reported to have registered at a 4.82 million annualized rate in August, the fastest pace in nearly two years, bringing the inventory to sales ratio 6.1 months. In addition, the median selling price of new homes jumped 17%, the highest annual price increase since August 2007. As the housing market continues to improve, we expect that improvement will ultimately translate into improved consumer sentiment.

Also of note, the Bureau of Labor Statistics (BLS) released its annual revision to previously released payroll reports. On a monthly basis, the BLS revises the previous month’s job report as additional data on hiring is collected. However, it takes several months to fully reconcile the data. Rather than re-revise the data multiple times, the BLS simply releases a benchmark revision annually. In the latest revision, released last month, the BLS reported that the U.S. Economy added 386,000 more jobs in the last twelve months than had originally been reported.