Weekly Economic

Commentary
Economy Review - Outlook

February 25, 2008

Economic Calendar
for 2/25 - 2/29
John Canally, CFA
Investment Strategist Monday, Feb 25 Wednesday, Feb 27 Initial Claims
LPL Financial Existing Home Sales Durable Goods wk 02/23
January January Friday, Feb 29
Tuesday, Feb 26 New Home Sales PCE
Core PPI January January
January Personal Income
Thursday, Feb 28
PPI GDP Price Index January
January Q4 Chicago PMA
Consumer Confidence GDP February
February Q4 U of Mich Consumer Sent
February

Executive Summary:
Last week’s incoming economic data revealed some signs of life in the housing market, and a stable
labor market, but also ushered in the unwanted return of the label “stagflation” to the lexicon of the
news media and market pundits. A quick look into the past suggests these wordsmiths have it wrong – again.

The housing market is front and center again this week, along with another appearance before Congress
by Federal Reserve Chairman Bernanke. The market will also get another look at fourth quarter real
gross domestic product, and digest important reports on the state of the nation’s manufacturing sector
in January and February. In addition, the January producer price index report (PPI) is likely to keep
’stagflation’ on the front pages of the nation’s business sections and at the top of every business news
broadcast – for at least another week.

Weekly Review:
Incoming Data Continue to Point to Slowdown, Not Recession
There was some good news out of the housing market last week, but it wasn’t enough to offset the bad
news from the manufacturing sector and the index of leading indicators – or at least it wasn’t enough
to convince the news media that we weren’t in the midst of a 1970s style bout of stagflation.

The housing related data released last week – the February National Association of Homebuilders
(NAHB) Index and the January housing starts report – suggest that the beleaguered U.S. housing

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Page 1 of 6
The good news here
is that the index – a
measure of homebuilder
sentiment – has stabilized
in recent months, after
hitting a 17 year low in
late 2007. The bad news
is that homebuilder
sentiment is still at a 17
year low!!
market may be in the midst of bottoming out. The February reading on the NAHB index came in at
20, up one from January’s reading. The good news here is that the index – a measure of homebuilder
sentiment – has stabilized in recent months, after hitting a 17 year low in late 2007. The bad news is
that homebuilder sentiment is still at a 17 year low!!
Home Builders: Housing Market Index (Composite)
SA, All Good = 100
80 80
60 60

40 40

20 20

0 0
85 90 95 00 05

Source: NAHB / Haver 02/25/08

Housing starts posted a modest gain in January, rising 0.8% to a 1.012 million annualized pace,
while building permits fell 3.0% in January to a 1.048 million pace. Housing bears will point out
that although the January housing starts and building permits data came in close to expectations, the
monthly decline in permits – which are not sensitive to swings in the weather – and the 10th consecutive
monthly drop in single family housing starts are a better reflection of the underlying weakness of
housing at the beginning of 2008. We point out that while many hurdles for housing remain – tighter
lending standards, high inventory of unsold new and existing homes, rising unemployment – other
factors such as rising home affordability, the recent declines in the number of unsold new and existing
homes and the housing related elements of the recently enacted fiscal stimulus package should begin
to help the housing market recover later this year.

Housing Starts: 1 Unit

SAAR, Thous. Units
2000 2000

1750 1750

1500 1500

1250 1250

1000 1000

750 750

500 500
85 90 95 00 05
Source: Census Bureau / Haver Analytics 02/25/08

LPL Financial Member FINRA/SIPC Weekly Economic Commentary | February 25, 2008 | Page 2 of 6
The label, a way to
describe the combination
of stagnant growth and
high inflation, first came
into the Wall Street
lexicon in the early to
mid 1970s, but was
actually coined by the
British Chancellor of the
Exchequer Iain MacLeod
in the mid 1960s.
In more normal times,
the Fed Chairman’s
semiannual “Humphrey
Hawkins” testimony to
Congress would be the
major focus of the week.
But because the Fed just
released an updated
economic forecast last
week and Fed Chairman
Bernanke testified
before Congress on the
economic outlook less
than two weeks ago on
Valentine’s Day...
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The news media made a big deal last week about the fourth consecutive monthly decline in the
index of leading economic indicators and a larger than expected reading on the consumer price index
in January. The combination of the weak leading indicators – along with the large decline in the
Philadelphia Fed’s index of manufacturing activity in February – and the unexpectedly large 0.4%
reading on the Consumer Price Index in January gave market observers license to use ‘stagflation’
to describe the current economic climate. The label, a way to describe the combination of stagnant
growth and high inflation, first came into the Wall Street lexicon in the early to mid 1970s, but was
actually coined by the British Chancellor of the Exchequer Iain MacLeod in the mid 1960s.
The term was widely used to describe the negative economic growth and persistently high inflation
that gripped the U.S. economy from the early 1970s through the early 1980s. Although there are no
“official” dates marking the beginning and end of those periods of stagflation, the first began during
the steep recession of 1973-75, when real GDP growth averaged -1.5% and inflation excluding food
and energy (core inflation) averaged 7.2%. The next episode came between early 1980 and 1982,
when real GDP growth averaged 0.1% per year, and core inflation averaged 8.1%. In contrast, over
the past 12 months, real GDP growth was 2.4% and the core inflation rate averaged 2.1%. So what we
have seen over the past 12 months or so can hardly be equated with the dreadful economic backdrops
of the mid 70s and early 1980s.
Stagflation?
10
Real GDP
Core Inflation
8
Annualized % Change
-2-
Mid 1970s Early 1980s Last 12 Months
Source: Bloomberg and LPL Financial Research
The Week Ahead:
Bernanke, Manufacturing and Inflation
In more normal times, the Fed Chairman’s semiannual “Humphrey Hawkins” testimony to Congress
would be the major focus of the week. But because the Fed just released an updated economic forecast
last week and Fed Chairman Bernanke testified before Congress on the economic outlook less than
two weeks ago on Valentine’s Day, this week’s testimony from Bernanke is not likely to break much
new ground. Of course, none of that will stop market observers and pundits from hanging on his every
word. Our view is that during his Valentine’s Day testimony, Bernanke left the door open for a 50 bp
rate cut - should conditions warrant - before the next scheduled FOMC meeting on March 18, and we
don’t expect him to deviate from that tone at this week’s testimony.
Weekly Economic Commentary | February 25, 2008 | Page 3 of 6

The market is expecting a
modest upward revision
to Q4 GDP to a 0.7%
gain, up from the 0.6%
gain reported at the end
of January. The impetus
for most of the upward
revision is likely to be
from the export sector.
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In addition to Bernanke’s testimony, the market will absorb the January durable goods orders report
this week, along with the February Chicago Area Purchasing Managers Index. Both are key gauges
of the health of the nation’s manufacturing sector and will be closely watched by market participants.
The “core” durable goods orders and shipments data will be especially closely watched, as there
have been big swings in aircraft orders in recent months, which have distorted the overall trend in the
manufacturing sector.
Mfrs’ Shipments: Nondefense Capital Goods ex Aircraft
SAAR, Thous. Units SA, Mil.$
30 30
20 20
10 10
0 0
-10 -10
-20 -20
-30 -30
90 95 00 05
Source: Census Bureau / Haver Analytics 02/25/08
On Thursday, February 28, the market will also get an update to the fourth quarter gross domestic
product data first released in late January. The market is expecting a modest upward revision to Q4
GDP to a 0.7% gain, up from the 0.6% gain reported at the end of January. The impetus for most of
the upward revision is likely to be from the export sector. The personal spending and income data for
January due out on Friday, February 29 are likely to be the most useful economic data released this
week, as the data will provide broad insight into the consumer’s income and spending patterns as 2008
began. The market is looking for small (0.2%) gains in income and consumption in January.
Weekly Economic Commentary | February 25, 2008 | Page 4 of 6
 Real Gross Domestic Product
The prospect for more SAAR, % Change
bad news on inflation 8 8
looms with the release of
the January PPI report on 6 6

Tuesday, February 26.

4 4

2 2

0 0

-2 -2

-4 -4
90 95 00 05

Source: Bureau of Economic Analysis / Haver Analytics 02/25/08

The prospect for more bad news on inflation looms with the release of the January PPI report on
Tuesday, February 26. The market is looking for a 0.4% gain in the PPI in January, which will translate
into a 7.3% year over year gain in the headline PPI, a figure that is sure to further flame the stagflation
talk. Core PPI is likely to be much more tame at around 0.2% in January and up about 2 to 2.5% over
the past 12 months.

PPI: Finished Goods

% Change - Year to Year SA, 1982 = 100
PPI Finished Goods less Food and Energy
% Change - Year to Year SA, 1982 = 100
8 8

6 6

4 4

2 2

0 0

-2 -2

-4 -4
90 95 00 05

Source: Bureau of Labour Statistics / Haver Analytics 02/25/08

LPL Financial Member FINRA/SIPC Weekly Economic Commentary | February 25, 2008 | Page 5 of 6
Important Disclosures
This report has been prepared by LPL Financial from sources believed to be reliable but no guarantee can be made as to its accuracy
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