This Week's Economic Indicators May Be DOA

With the majority of 3rd quarter earnings now in the public domain, equity markets continue to live in a world severely lacking in quality information. Our re-test of market lows late last week is evidence enough that we’re not sure the economy will rebound at all in 2009. We’re hearing of curtailed production and lowered sales estimates within multiple key industries, sometimes just weeks after quarterly conference calls.

Staring into the Abyss

We desperately want to know how deep the bottom will be, and this week’s lineup of economic indicators will give needed insight into two major trends - declining industrial production, and falling commodity prices. The data won’t be pretty, and the markets’ reaction will be a true test of how much economic weakness is currently baked into stock prices.

The key indicator of the week is Monday’s Industrial Production/Capacity Utilization release (the link will take you to the current release once it’s live Monday), which will show us month-over-month changes from September, and also give us the new indexed value, for which 2002 is currently the base year.

Barely Budged Since 2002

We are already depressingly close to just 100% of 2002 production levels (a rebound year itself following the 2001 recession), with the September reading at 107.3. How bad will October’s reading be? The consensus is for between a .1% decrease and .5% increase over September, but any implied growth or flatness is illusory, as the hurricanes of September halted energy production in the Gulf regions to the tune of about 2.25 percentage points.

So instead of a modest .5%  or so decrease in the September reading, we saw a decrease of 2.8%. If we remove the outlier effects of the hurricanes, the October midpoint estimate of .2% growth actually implies a roughly 2% drop in production. If this number holds up, it would be the biggest monthly drop since the data series began in 1986.

If the headline number comes in notably worse, expect this to spook the markets in a major way. Because while we all know that October was an “over the cliff” month for financial markets, it is likely not the trough of production. Right now, November looks to be tracking worse.

Including the effects of September, the 3rd quarter decline in industrial production was 6% annualized, and given the historical precedents we’re setting left and right, there’s no reason not to expect the 4th quarter to decline in the range of 6-8% annualized. For context, the prior worst month going back to 1986 was a -7.5% showing in the first quarter of 1991.

Are Producer Prices Seeing Relief?

The other major indicator of the week is the PPI, due out Tuesday. What longs are hoping to see here is some pass-through of the massive price declines seen in commodities over recent months making their way into producer prices. The estimate calls for a 1.5% decline following a .4% drop in September.

If the PPI comes in lower, look for this to boost the industrial & consumer names, and likely the broad market with it. Given all the margin pressure coming from the demand side, it would be nice to see some relief in the way of input costs and intermediate goods.

Parting Thoughts

We’ve also got housing starts and weekly jobless claims (as always) out this week, but I don’t see housing starts driving much except scary headlines about the new lows we’re setting. The bigger issues within the housing market remain inventories and prices.