Housing starts came in better than expected.  Month on month data was down 5.9% after an upward revision to January.  Econoday has the details:

“February’s annualized pace of 0.575 million units beat the market consensus for 0.565 million units and was up 0.2 percent on a year-ago basis. January was revised up to 0.611 million units from the original estimate of 0.591 million units. The decline in February was led by a 30.3 percent decrease in multifamily starts, following a 18.5 percent gain in January. The single-family component slipped 0.6 percent after a 4.4 percent rise the prior month.

By region, the February drop in starts was led by a 15.5 percent fall in the South with the Northeast decreasing by 9.6 percent. Both regions were hit by heavy snow storms during the month. Starts in the Midwest rose 10.6 percent while the West gained 7.9 percent.”

The big news of the day will be the Fed decision.  Investors are expecting no change in rates or the statement.  Market participants are entering the decision in a fairly optimistic manner.  The dollar is trading down against most other currencies and equities are up almost 0.5%.  Any hawkish tone in the statement could ding the sentiment in most markets.

When the Federal Open Market Committee (FOMC) meets (today), self-described “inflation hawk” Dr. William F. Ford, Weatherford chair of finance professor at Middle Tennessee State University and a former president of the Federal Reserve Bank of Atlanta,  isn’t expecting any uptick in the benchmark federal funds rate from the current 0.25% level. In fact, he is resigned to the likelihood that the Federal Reserve Board will keep rates artificially low for the foreseeable future.

And that, he says, would be a terrible mistake.  According to Ford, the recession is over, and the Fed’s top priority now should be making sure inflation doesn’t rear its ugly head. “We now have negative real interest rates on a persistent basis, which is “never a good idea,” he says. “It’s not a sustainable policy.” He argues that the central bank is apparently basing its interest rate policy on inflation indices that don’t reflect rising energy and food costs, ignoring the fact that “everybody heats or cools their home and eats.” There’s a real danger, he says, that “the Fed will wait too long to back out of its low interest rate policies. They’ve boxed themselves in and created a danger that they’ll wait too long before mopping up more than a trillion dollars of excess liquidity on the Fed’s balance sheet.” This excess liquidity, he warns, is like “gas in a ditch waiting for someone to drop a match.”

Ford contends that it would take only a small hike in the fed funds rate—a mere 0.25%—to dampen inflationary expectations. While he doesn’t look for a change now, he thinks that chairman Ben Bernanke will feel the pressure to  “get off the dime” in a few months, when, he predicts, the National Bureau of Economic Research will declare that the recession actually ended last summer, about 18-20 months after it began. The NBER is considered the official arbiter of economic cycles.

Failure to head off inflation sooner rather than later, he cautions, may cause a sharp rise in the yield curve, which would dramatically increase the cost of servicing the national debt, now approximately $12.6 trillion. Based on President Obama’s budget forecasts, it’s heading for $14 trillion plus, Ford points out.  “Raising the fed funds rate by one quarter percent won’t do anything negative,” he says. “And it could have positive effects that would put a lot of people at ease.”

Given Ford’s views on monetary policy, it’s not surprising that he isn’t thrilled over the Obama Administration’s apparent selection of Dr. Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, to serve as vice chairman of the Board of Governors.  Late last week, the White House announced that Dr. Yellen, along with Peter A. Diamond, an economics professor at the Massachusetts Institute of Technology,  and Sarah Bloom Raskin, Maryland’s commissioner of financial regulation, were the leading candidates to fill three open board seats. Calling Dr. Yellen “an ardent easy money advocate,” he says he would prefer another Bay Area economist, Stanford Professor and Hoover Institution senior fellow John Taylor. A former Treasury under secretary in George W. Bush administration, Taylor is the formulator of the so-called “Taylor Rule,” which, in simple terms, calls for higher rates to curb inflation when inflation exceeds target levels, or when its output surpasses full-employment levels, and to cut rates when the reverse occurs. “John Taylor is brilliant,” says Ford. Another good choice for vice chairman, he says, would be Thomas Hoenig, president of the Kansas City Fed, who has also criticized the Fed for not moving aggressively to deter inflation.

Inflation is the one wild card in Ford’s otherwise optimistic economic outlook. “If inflation doesn’t bite us,” he says, he projects a “pretty good rebound, a V-shaped recovery. The trend in GDP growth is strong.” Still, he agrees with the consensus view that unemployment will likely remain in the 9% area through year-end 2010, possibly declining to 8% by the end of 2011, and below 7% in two to three years. The likelihood of a “double dip” recession, he figures, is about “10% or less.”

As for other shoes to drop in the financial crisis, Ford confident that the European financial authorities will make sure Greece doesn’t jeopardize economic recovery on the Continent. “The Germans will take of it,” he predicts. And in the U. S., he expects that an improving economy will eventually help ease fiscal pressures for most state and local governments by generating higher tax revenues over the next year or two.

Professor William F. Ford holds the Weatherford Chair of Finance in the Jennings A. Jones College of Business at Middle Tennessee State University. He formerly served as dean of the Business School at the University of Denver; president of the Federal Reserve Bank of Atlanta; president of First Nationwide Bank; senior vice president of Wells Fargo Bank; and chief economist of the American Bankers Association. He holds a B.A. in economics (summa cum laude) from the University of Texas and M.A. and Ph.D. degrees from the University of Michigan. He is a frequent commentator on Fed policy on Bloomberg Television, CNBC, and other news stations.

“We recommend buying a group of names with above-average yields that have shown an ability to grow dividends, and that possess a balance sheet that allows for sustainable payouts. Following a period of economic and financial duress we argue for added focus and value on companies that grew their dividend in 2009 and have plans to do the same in 2010. We screened our coverage with the following criteria to drive our core list of names that benefit from yield plus dividend growth”:

1) High dividend yield. We first screen our coverage universe for companies yielding greater than 2.5% on analyst projections for 2010 dividends.
2) Consistent payout. We remove companies that cut dividends in 2009.
3) Prospective dividend growth. We then further screen for names our analysts expect will grow their dividends in 2010.
4) FCF yield. Cash flow is necessary to maintain sustainable dividend growth; we exclude companies with FCF yields below 5%.
5) Balance sheet strength. Weak balance sheets limit both the capacity and propensity to pay and raise dividends; we remove companies with net debt/equity greater than 100%.
6) Buy rating.

Based on this criteria they came up with the following 10 names:

• AT&T (T)

• Verizon (V)

• McDonalds (MCD)

• Abbot Labs (ABT)

• Home Depot (HD)

• Molex (MOLX)

• Time Warner (TWX)

• Analog Devices (ADI)

• Illinois Toolworks (ITW)

• 3M Corp. (MMM)

Source: GS

Long time readers of Thoughts from the Frontline will be familiar with the name The Liscio Report. It is one of my “secret” sources of high quality analysis on a wide range of topics including taxes, employment and the underpinnings of the economic headlines that we read which can be so distorted. I say secret because they get nowhere near the attention their work deserves. Philippa Dunne & Doug Henwood, authors of The Liscio Report, do actual on the phone conversations with each of the various states on their tax collections, employment and so on. I find their primary research to be invaluable. Their real time proprietary research based on state withholding and sales tax receipts gives their clients a unique insight into the state of the US economy.

I have talked them into letting me send out their most recent letter, which I found very informative. While their work is not inexpensive ($7,500 annually), for hedge funds, banks, proprietary trading desks and those who need to know what is actually happening as opposed to whatever spin is being put out in the press, you should check them out at www.theliscioreport.com.

And before we jump into their report, I feel the need to comment on the revelations this last week about Lehman and what looks like can only be called fraud. How much more of this is going on? Regulators now have a road map to know what to look for. Auditors are now on notice that this lack of transparency and cooking the books at quarter’s end must not be condoned.

And while we re on the topic of transparency, for God’s sake, can’t we get credit default swaps on an exchange before they blow us all up again? Please? Someone? Anyone? It’s been two years. It’s what brought Bear and Lehman down. Bluntly, the reason the banks oppose this is that the commissions for an OTC credit default swap are astronomical when compared to what will become a $10 commission on an exchange.

OK, I’ll now stop my rant, and allow you to enjoy The Liscio Report. Have a great week.

John Mauldin, Editor
Outside the Box

Revenues stabilizing, though it helps to be rich

The Liscio Report

By Philippa Dunne & Doug Henwood

In February, 56% of the states in our survey met or exceeded their forecasted sales tax collections, up from 50% in January, and 13% reported positive collections over the year, down from 30% in January. Our intensity index, over-the-year rate of change weighted by state population, was –2.33%, about even with January’s –2.28%, and the aggregated divergence from forecast held in the positive range at 0.26%, down a bit from January’s 0.5%.

Both of the two last measures are showing real improvement: the over-the-year change, although still negative, is well off its record-setting lows (see below) and the divergence from forecast, with a few small exceptions, hasn’t been positive since the fall of 2006.

For the various geographic regions, the good news is generally of a muted variety, and uneven no matter how you break them up. The best results came from states with large investment banking sectors–a few were both positive over the year and above forecast, one quite substantially so. The housing-bubble states without such sectors are slowly clawing back in the long, slow haul they anticipated, with one actually beating forecast by a hair.

The Midwestern manufacturing states continue to report mixed results. One reported the strongest year-over-year gains in the survey, and our contact there believes the relative stability of the major auto-makers is allowing “those who have jobs” to spend a bit more freely. Other states in the region did not do so well, but continue to report a stabilizing trend.

Greatest impatience was expressed by revenue officials around the country in smaller states with mixed economies. They expect to see revenues now moving into positive territory and another month of disappointing results is hard to take.

Affluent tightwads

For the last two years, Gallup has been asking 1,000 Americans every day how much they’ve been spending at stores, restaurants, gas stations, and online. The average for upper-income households–those with incomes above $90,000–in February plunged to a new low of $98, down 13% from January. The numbers aren’t seasonally adjusted, so the monthly changes have to be taken with a grain of salt, but the yearly change is a sharp –19%.

By contrast, spending by middle- and lower-income households has been more or less flat for a year. Both are way off their May 2008 peaks–down by almost half for both groups.

As Gallup’s chief economist, Dennis Jacobe, pointed out in reporting these results on Wednesday, the retail economy badly needs freer spending by the well-off. That’s where most of the discretionary juice is; households of more modest means just don’t have the money to ramp up spending beyond the level of basics.

Jacobe attributes this tight-fistedness to “the new normal”–a general cautiousness born of economic uncertainty. Upper-income households are much less exposed to the vagaries of the job market than middle- and lower-income ones. For example, as a study by the Center for Labor Market Studies at Northeastern University reported in February, at the end of 2009, the average unemployment rate for the upper fifth of the income distribution was 2%; for the middle fifth, it was 6%; and for the bottom fifth, it was 19%.

the new normal

It’s not just Gallup that’s talking about a new regime of lower spending. In a new joint report, the consulting firms Kantar Retail and Price Waterhouse Coopers declare that “an enduring shift has taken place as a result of the Great Recession.” Conspicuous consumption will give way to a more mindful sort of spending, and “rampant deal-seeking will be replaced by more purchases selectivity.” Over the near future, people will apply the tools and consciousness they learned during the recession even as the economy recovers. Shoppers will put more effort into buying. Gone are the days of recreational browsing and impulse buying; shoppers will plan their purchases more, making lists and Googling for deals. There will be a stigma attached to wasteful spending–and purveyors of luxury goods will have to content themselves by selling to the actually rich alone, without any help from the aspirationally affluent. “Good enough” will take the place of the very best. The mix of goods may change. As Boomers approach retirement, they’ll spend less and save more, ceding the cyclical lead to Gens X and Y–which means a bigger role for high-tech gadgetry. But overall spending is likely to remain muted.

Or so they say. The older among us, or the subset of those with still-intact memories, will recall that similar things were said in the early 1990s, when private labels and generic goods were all the rage. That trend faded as the job market recovered, the stock market bubble got going, and the former Chevy driver eventually just had to have an Escalade. Still, this sobriety is likely to be with us for some time–at least until the job market seriously recovers.

That said, spending on nonessentials has been recovering in recent months. Its growth rate is still lagging that of essentials, but the gap is closing. That’s to be expected, but a return to 2006 certainly isn’t.

By the way, as the graph below shows, the yearly change in sales tax collections in the SDI’s universe correlates very nicely with movements in spending on nonessentials (r=0.87). This makes sense, since so many essentials are exempt from sales tax, but it’s always gratifying when you can confirm good sense empirically.

Is this recovery secretly strong?

Every now and then you hear respectable analysts claiming that this recovery is stronger than anyone knows, or admits, or wants to contemplate. Rodney Dangerfield, who couldn’t get no respect, is invoked in support of this claim.

We wish we could find something this encouraging in the data. To take the measure of the recovery, we’ve put together four cycle graphs, showing the behavior of some important indicators for the year before and after business cycle troughs. In all but one case (more on that one in a bit), values are indexed so that the trough month = 100. (We’re assuming that the trough of the recent recession was in June 2009.) But instead of the usual recovery average, which blends together all upturns since the end of World War II (and which is how we’ve done this exercise most times in the past), we’ve done two averages–one representing the weak recoveries of 1991–1992 and 2001–2002, and the other, the strong recoveries of 1975–1976 and 1982–1983.

Graphed below are payroll employment and the unemployment rate. The recent trajectory of both measures is a lot closer to the “weak” line than the “strong.” Employment is actually weaker than the “weak.” In fact, if employment were hugging the “weak” line, there’d be over 600,000 more jobs in the economy than there were in February. If it were following the “strong” path, there’d be 3.2 million more jobs. Unemployment is close to the “weak” line; if it were following the “strong” path, the jobless rate would be a full point lower than it was in February.

Of course, the job market is only one part of the economic picture–though it’s a very important part. What about the broad business cycle indexes? These have the virtue of giving a composite picture of all the economy’s major aspects–and using them is a nice check on the temptation to cherry-pick data to prove the point you want to prove.

Two of those composite indexes are graphed below–the Conference Board’s coincident index and the Chicago Fed’s National Activity Index (CFNAI). The Conference Board index, after having fallen hard in the recession (like the employment indicators), is almost a dead-ringer for the “weak” line.

The CFNAI is the only one of these indicators that isn’t indexed so that the trough month is set to 100. The reason for that is that the index itself is normalized over time so that its long-term average is 0, which is also the economy’s long-term trend growth rate. Any value above 0 is over trend; any under 0, under trend. A value of 1 is a standard deviation above average. Values above .70 are thought to be where the economy is running far enough above trend that inflation is a worry. Historically, the CFNAI has proven to be a good real-time measure of the state of the business cycle.

Here too, we’re much closer to “weak” than “strong”–and still below 0. Seven months into a strong recovery, the CNFAI has averaged 1.0–meaning that we’re more than a standard deviation below a strong recovery’s reading.

So, no, this is not a Rodney Dangerfield recovery. Maybe it will become one–but we doubt that the markets will be inclined to badmouth the strength of the thing in the coming months.

Philippa Dunne & Doug Henwood

Source: Bloomberg TV

From Daily Futures:

U.S. Economy
The Federal Reserve said that industrial production was up .1% in February, slightly better than expected. The June 2011 eurodollars ended up .05 at 98.425.

The New York Federal Reserve’s regional index of manufacturing fell from 24.9 to 22.9 in March, better than expected.

The National Association of Homebuilders sentiment index fell from 17 to 15 in March, weaker than expected. May lumber closed down its $10 daily limit at $273.00.

The June U.S. dollar index closed up .425 at 80.50, said to be supported by disappointment that Europe has not yet come up with an aid package for Greece.

Grains and Cotton
The USDA said today that South Korea bought 275,000 tons of U.S. corn. May corn was down a penny at $3.632.

The USDA said that last week’s export inspections of:
Corn totaled 36.5 million bushels, up 4% from a year ago.
Soybeans totaled 31.5 million bushels, up 32% from a year ago.
Wheat totaled 9.2 million bushels, down 29% from a year ago.
May soybeans ended up 4.5 cents at $9.30.

July wheat fell 6 cents to $4.92, pressured by plentiful supplies and a slow pace of exports.

Livestock
June cattle closed up .80 at a new contract high of 93.60, supported by declining cattle inventories and a pickup in beef demand.

Cocoa
May cocoa dropped $54 to $2,866, pressured by today’s stronger U.S. dollar.

Metals
May copper fell 6.50 cents to $3.315 with more talk that both China and India are trying to restrain their economies.

Currencies
Statistics Canada said that new vehicle sales were roughly unchanged in January at 128,426 units. Also, national net worth increased .3% in the fourth quarter to C$6 trillion. The June Canadian dollar finished down .25 at 98.02.

Canada’s Real Estate Association said that existing home sales were down 1.5% in February.

• The game of risk (Jeff Saut turns cautious) -  RJ

• Asset allocation in a crisis -  CFA

• Empires on the edge of chaos -  Fergusson

• Dodd’s financial reforms won’t fix the banks -  RCM

• How useful is Shiller’s PE? -  IBD

• Taking on China -  Krugman

“New orders, shipments, inventories, delivery times and employment are all posting month-to-month increases in New York state’s manufacturing region, offering a convincing indication of building strength at the national level. The Empire State’s general business conditions index did slow by more than 2 points to 22.86 in March, but the reading is still far over zero to indicate significant month-to-month expansion.

The headline reading masks wide strength in the individual indexes: new orders 25.43 in March vs. 8.78 in February, shipments 25.58 vs. 15.14, inventories 4.94 vs. 0.00, delivery time 2.47 vs. minus 6.94, employment 12.35 vs. 5.56.”

The industrial production report was a bit more mixed.  While the headline figures came in better than expected a little digging reveals some marginal weakness.  The production figure was boosted by sizable gains in utilities output which is primarily weather related.  Capacity utilization at 72.7, was better than analysts estimates of 72.4, but continues to substantially lag the 80 level that represents an economy that is “recovered”.   The pace of recovery certainly appears to be slowing as the utilization rate barely eeks out a month on month gain.

The market is largely ignoring the two reports which were essentially in-line with expectations.  Stocks are falling this morning on concerns that China’s economy will slow in the coming months as policymakers tighten their monetary & fiscal stance in order to reign in an overheating economy.

The British pound came under heavy selling pressure at the European opening on Monday as investors reacted to a weekend reminder that AAA credit ratings have to be earned. And with fiscal integrity on the chopping block as a result of the forthcoming election, the perceived risks to the loss of such status was a convenient excuse for traders to lop a cent off the value of sterling versus the dollar. Global equity prices are lower to start the week and there is an air of risk aversion about the market tone even before U.S. markets are open.

British pound – The pound is safe for now according to a weekend report from Moody’s Investor Services, but traders wasted no time rehashing the story using it as reason enough to bash the pound the unit one more time. It was a notable laggard against the dollar and quickly slumped by more than a cent to as low as $1.5020 after a Friday close at $1.5184. The pound has since bounced back to $1.5060.

Comments carried by one regional newspaper cited Bank of England policy-member Kate Barker as forewarning about a possible quarter of negative GDP growth. Perhaps this is the real shocking event that hurt the pound today. The revised fourth quarter data showed a 0.3% growth recently marking the official recovery from fallen fortunes throughout the recession. However, a semi-official warning of a worsening outlook comes out of the blue and is set against a backdrop of an election that might result in political weakness in which the ruling party might make little headway in reducing the deficit. The pound also fell against the euro to stand at 91.17 pence while the pound dropped to ¥136.55.

U.S. Dollar – The FOMC begins a two-day meeting on Tuesday with no one looking for any change in official rates. However, the policy statement will be closely examined to ensure the Fed hasn’t changed its subtle tone.

Euro – Earlier weakness saw the euro ease to $1.3701 as ministers from the EU met in Brussels on Monday to thrash out principles on which a framework to assist Green might be built. The euro appears to be suffering from another long wait at the end of which there is no news to report, either good or bad. In early trading the euro declined to $1.3711.

Japanese yen – The yen awaits the outcome of this week’s two-day meeting at the Bank of Japan with dealers anticipating a further degree of easing, however the Bank might manage it. The top bet is for an extension of the ¥10 trillion fund via which the central bank has so far granted liquidity to the banks in an effort to encourage them to lend.

The yen maintained its weaker bias on Monday as traders continued to favor the dollar, which has built on the momentum it gathered Friday. At ¥90.70 the dollar remains within spitting distance of Friday’s ¥91.08 high. Against the euro the yen remains unchanged at ¥124.50.

Aussie dollar – Weakness in Asian equity markets hampered the progress of the recent advance in the Australian dollar, which on Friday traded at a seven-week peak against the dollar. Monday’s less enthusiastic mood contrasts to any of the recent reports indicating strong growth among Australia’s trading partners and ahead of minutes from the recent RBA meeting at which members voted for a quarter point increase in interest rates. Currency traders will be looking for hints as to how much further the central bank feels rates should go. Ahead of the trading day in New York the Aussie is slightly lower at 91.31 U.S. cents.

Canadian dollar – The Canadian dollar has maintained Friday’s strength spurred by another firming in employment conditions and the tailwinds of strong retail sales growth in its major U.S. market. Since its propulsion to 98.48 U.S. cents in the aftermath of Friday’s data the Canadian unit has not fallen below 98.07 cents since. Currently it’s trading at 98.25.