Beige Book? More Like the 'Blah' Book

by: Zacks Investment Research

The Beige Book is a collection of mostly anecdotal information from around the country collected by the twelve Federal Reserve districts. In general, it pointed to growth that was continuing but at a slower pace than the already anemic level of the previous months.

No signs of a double-dip, but not a lot of evidence that we are about to start a vigorous uptrend in the economy either. For the most part, the report confirmed what we already knew from other economic reports. Here are some of the key passages from the report, along with some of my thoughts mixed in:

Continued growth in national economic activity during the reporting period of mid-July through the end of August, but with widespread signs of a deceleration compared with preceding periods. Economic growth at a modest pace was the most common characterization of overall conditions...

Economic growth at a modest pace seems to be a phrase the Fed is using a lot these days. The questions is, should we expect better than that?

There are two schools of thought. In most of the cases where the economy goes into a deep recession, the path out of it is usually very vigorous. However, recovery that happens after recessions that are caused by financial crises tend to be very slow and lackluster. There are not a lot of data points on U.S. recessions caused by financial panics, but there are plenty of examples from other advanced economies.

This case is a bit unique in that is was a very deep recession that was caused by a financial panic. So far the financial panic side seems to be outweighing the deep side.

Reports on consumer spending were mixed but suggested a slight increase on balance. Most Districts reported that non-automotive retail sales rose compared with the previous reporting period or were above their levels from 12 months earlier.

Being above a year ago is not a huge feat, since that was near the bottom of the recession, making it a very easy comp. Sequential growth is harder to achieve. There's not a lot of it, but at least it is still positive.

Most Districts also reported that sales of new automobiles and light trucks were largely stable or up slightly during the reporting period, and contacts were optimistic for stable sales or slight growth over the balance of the year. A few reports indicated that inventories for various goods remained near desired levels despite slower sales in some cases, as retailers have been practicing very tight inventory management.

That is probably very good news for companies like Ford (NYSE:F), since they have made great strides in bringing their costs under control. They are solidly profitable now with sales running at under a 12 million a year pace, down from well over 16 million a year before the recession started.

The tight inventory management probably means that we will get no contribution from increasing inventories for third quarter GDP growth. That has been a major -- but diminishing -- contributor to growth in the last three quarters.

Reports from most Districts pointed to consistent gains in travel and tourist activity, with pickups evident in the business and leisure segments alike.

This is a good sign since leisure travel is a highly discretionary item, and shows more confidence on the part of consumers. If you are afraid you are going to lose your job, you don’t go on a vacation. Also, travel and tourism is a very labor intensive business, so a pick up in hotel occupancy is likely to lead to more jobs. When on vacation, people tend to eat out, and that will also spur more jobs.

Manufacturing activity expanded further on balance, although the pace of growth appeared to be slower than earlier in the year. Most Districts reported further gains in production activity and sales across a broad spectrum of manufacturing industries.

Manufacturing has been one of the real bright spots in this recovery, particularly when compared to the last two recoveries. I suspect that some of the slowdown in growth there is related to the stronger dollar hurting exports and making imports more competitive here.

Reports on capacity utilization were mixed. Manufacturers of high-tech products have been operating near maximum capacity of late, although this partly reflects a substantial decline in industry-wide capacity over the past three years.

That should be good news for the semiconductor industry, where there is a high degree of operating leverage. If the plants are running at near-maximum capacity, it is likely that they are making a lot of money. That would also favor the firms that have the manufacturing capacity like Intel (NASDAQ:INTC) and Analog Devices (NASDAQ:ADI) versus some of the smaller “fabless semiconductor” firms.

Capital spending plans for manufacturers and firms in other industries generally indicate little change or modest increases in coming months.

That is a bit on the disappointing side. We need strong capital investment if the economy is going to pick up steam. Obama’s new proposal to allow companies to expense equipment purchases rather than depreciate them over their useful lives might help this part of the economy pick up a bit more steam.

Activity in residential real estate markets declined further. Most District reports highlighted evidence of very low or declining home sales, which many attributed to a sustained lull following the expiration of the homebuyer tax credit at the end of June...Residential construction activity declined in most areas in response to weak demand.

The real estate market, especially the residential real estate market, has been the millstone around the neck of the economy, and it does not look like that is changing. We had a bit of a temporary respite due to the tax credit, but that simply pulled sales that would have been made in the summer into the spring.

We had a bit of a party; now it is hangover time. Historically, residential investment is the key locomotive pulling the economy out of a recession. The locomotive is derailed this time around.

Demand for commercial, industrial and retail space generally remained depressed. Vacancy rates stayed at elevated levels in general and rose further in a few Districts, placing substantial downward pressure on rents.

Don’t look for non-residential construction to take the place of residential construction. Normally non-residential construction kicks in much later in the economic cycle, so it is not that unusual that it is weak (residential construction is classic early cycle), but its weakness is not helping matters.

Lending activity was stable to down slightly on net. Most Districts reported little or no change from existing low levels of commercial and industrial lending, as businesses remained quite cautious about expansion plans...with declines driven by weak business lending stemming in large part from uncertainty about future economic conditions. Consumer lending remained sluggish in general...the role of households' ongoing efforts to reduce their debt burdens. A recent flurry of refinancing activity spurred increased demand for residential mortgages, but new-purchase mortgage originations remained quite sluggish in general.

Mortgage refinancing is providing an important boost to the economy, as mortgage rates are at levels not seen for decades. However, a very large number of people are not able to participate in it since they owe more on their current mortgage than the house is worth, or have only a small sliver of positive equity.

For those who have the ability to refinance, it can save people hundreds of dollars a month, money that can be spent elsewhere. It is an open question of how much the decline in lending is from banks not wanting to lend and how much is from businesses not wanting to borrow. Clearly both factors are at play.

Demand for agricultural products continued to expand, and producers benefited from relatively tranquil supply conditions. Crops and livestock generally sold well in Districts with extensive agricultural sectors, including Chicago, Minneapolis, Kansas City, Dallas and San Francisco. Domestic growers have seen increased demand for grains and other commodities as a result of shortages overseas. Growing conditions were supportive of relatively high yields in most areas.

Things are going well down on the farm, as U.S. farmers are benefiting from crop failures elsewhere in the world, most notably the drought and heat wave in Russia. It is noteworthy that the lowest unemployment rates in the country are in places like the Dakotas and Nebraska, which have very large farm economies.

Upward price pressures were very limited during the reporting period, with the exception of selected food commodities and industrial materials.

Deflation is probably a bigger threat right now than runaway inflation. The bond market is practically screaming that inflation is not a big worry right now.

Wage pressures remained modest overall. Of Districts commenting on wages, most identified little or no upward pressures or increases.

With 9.6% unemployment, that is hardly a surprise.

Overall, the tone of this Beige Book was a bit softer than the tone we were seeing a few months ago. Nothing disastrous, but not enough growth to make much of a dent in the huge army or the unemployed. Maybe that is why the call it the Beige book and not the neon orange book; at least this time around beige seems to be a very appropriate color.