Prepared by AIC Investment Advisors, Inc.

The Commerce Department revised its second quarter Gross Domestic Product (GDP) annual growth rate downward to 3.3% from its earlier estimate of 3.6%. The second quarter growth rate follows a first quarter annual growth rate of 4.9%. The major change from the month earlier GDP estimate was in the trade deficit which increased an additional $4.0 billion and reduced the second quarter growth rate by 0.2%. One noteworthy trend was the rapid rate at which businesses were investing in new capital equipment. Business increased their investment in equipment at a 23.0% annual rate in the second quarter–the fastest rate in fourteen years. Economists expect that third quarter GDP growth will fall within a range of 2.5% to 3.0%. The fourth quarter GDP annual growth rate is expected to be less than the third quarter at this writing.

The economy continues to expand at a moderate rate. Assuming that this pattern holds true for the fourth quarter, the Federal Reserve is unlikely to increase short-term interest rates–another plus factor for the economy.

Manufacturing activity increased sharply in August as output rose to the highest level of the year. Production increased 0.7% following a more modest rise of 0.4% in July. Production facilities operated at 83.9% of capacity, the highest rate in nearly two years. The majority of the increase was accounted for by a 10.0% rise in automobile and light truck production. However, even excluding the auto and truck contribution, industrial production rose 0.5% in August.

Production in the mining sector was 0.9% lower in August, following a 0.5% drop in July; power production by utility companies declined 1.1% during the month.

Production is likely to remain strong during the fourth quarter of the year, and inflationary pressures are expected to remain subdued.

New factory orders for durable goods rose 2.7% in August accordingly to the latest report from the Commerce Department. Rising demand for electronic goods and aircraft fueled the advance–the third consecutive advance in durable goods orders. On a year-over-year basis, orders were up better than 11.0%. Orders for aircraft and parts soared 51.6% following a drop of 31.5% in July. Orders for electronics roared ahead 28.4% after recording a drop of 12.3% in July. Durable goods orders fluctuate greatly from month to month, consequently, data for one month may skew the longer-term picture. However, durable goods orders rose 2.8% in August even if the volatile aircraft and transportation segments are excluded. A 6-month moving average of durable goods orders indicates growth at a rate slightly in excess of 6.0% and turning upwards in recent months. Moreover, unfilled orders for August were 1.4% higher than a month earlier which is a positive sign for continued manufacturing activity during the months to come. Some slowdown is expected in the rate of manufacturing growth in September. The latest report from the National Association of Purchasing Managers indicates that its composite index declined to 54.2% in September from 56.8% in August.

In summary, the manufacturing sector should continue to show moderate growth, but at a rate that will not impact prices during the foreseeable future.

The Commerce Department reported that retail sales in August rose a less-than- expected 0.4% to an adjusted $213.5 billion despite back to school shopping. The slight increase was the third consecutive monthly gain. On a year-over-year basis, retail sales rose 5.3% from a year earlier. Excluding automobile dealerships, the year-over-year increase in sales was a seasonally adjusted 4.9%. The gains in retail sales are consistent with a gradually expanding economy. The outlook is for continued growth in sales in the 3.0% to 4.0% range on a year-over-year basis.

The Conference Board reported that its index of Leading Economic Indicators (used to forecast changes in the economic activity six-to-nine months ahead) rose 0.2% for the month of August, to 104.3, from the July reading of 104.1. Seven of the ten components in the composite index of the leading indicators increased in August: the money supply rose 0.16%; orders for consumer goods, increased 0.1%; the average workweek, rose 0.03 and slower deliveries increased the index 0.02%. A 0.01% increase in plant and equipment orders, the interest rate spread, and stock prices also added to the index. On the downside, unemployment fell 0.11%, consumer expectations dropped 0.03%, and building permits declined 0.01%.

The index of Coincident Indicators rose 0.3% in August to 116.8 while the index of Lagging Indicators increased to 104.9, up 0.3% from July's reading.

The Commerce Department reported that its index of consumer prices (CPI) increased a seasonally adjusted 0.2% in August (identical to July's increase). The core rate of inflation (excluding food and energy prices) rose a more modest 0.1% in August from a month earlier. Seven of the eight components of the CPI rose in August. The only decline was in apparel, which decreased 1.0%. Of the CPI components rising in August; energy prices rose 1.7%; transportation and “other” increased 0.6%; food and drink was 0.4% higher; both medical care and entertainment rose by 0.2%; housing rose a slight 0.1% in August.

The Producer Price Index (PPI), as tracked by the Labor Department, rose a seasonally adjusted 0.3% in August, following a modest decline of 0.1% in July. The core rate of inflation at the wholesale level increased by a slight 0.1% in August, offsetting a similar decline a month earlier. Prices rose along the entire production pipeline; finished goods were up 0.2%; intermediate goods rose 0.4%; crude supplies rose a hefty 7.1 %. Energy prices rose a steep 1.4% in August and accounted for approximately two-thirds of the increase in PPI during the month.

Sales of new single-family homes dropped 2.2% in August to a seasonally adjusted rate of 800,000 units, according to the Commerce Department. New home sales in July rose 0.4% after surging a robust 6.7% in June. Notwithstanding the drop in July sales, the housing industry views the market as healthy with many families trading up to more expensive residences. August's rate of 800,000 new home sales marks the 20th consecutive month that sales have been above the 700,000 level–the longest such stretch in nearly 20 years.

Mortgage rates, an important element of the housing market, are at a 19-month low of 7.40% (Fannie Mae) for a fixed 30-year mortgage. This mortgage rate makes homes more affordable for many prospective buyers and for those wanting to trade-up to larger dwellings.

Sales of new homes were very weak in the West which had been the catalyst for the market earlier in the year. Sales in the West dropped 12.6% in August. New home sales in the Midwest also fell by 4.5% in August from the month earlier. Gains in home sales came from the South, which recorded an increase of 3.1% in August, and the Northeast which experienced a turnaround–with sales rising 15.6% in July. The median price for a new home rose in August to $145,000, 5.8% above the August 1996 levels.

The supply of new homes for sale rose to a 4.4 month supply at the current monthly sales rate. This measure of demand is the estimated time it would take to sell the currently available 284,000 units on the market at the current sales pace. Home builders typically view anything shorter than 5 months supply of homes as an indication that the market can still absorb additional building. The new housing market appears reasonably strong and further gains may be forthcoming in the months ahead.

The National Association of Realtors reported that existing home sales showed solid growth in August, rising 3.3% to a seasonally adjusted rate of 4.32 million units. The August rate was the highest ever recorded since the National Association of Realtors began tracking the index nearly 30 years ago. As opposed to new home sales, sales of existing homes during August fell in the Northeast while rising in the West, South and Midwest.

In contrast to the recent positive trends in new and existing home sales, housing starts fell 4.8% in August to an annual rate of 1.36 million units. The August decline follows a similar drop of 4.7% in July. Whether or not the weakness in housing starts is a precursor of a weakening sector remains to be determined in the months ahead. Single-family unit starts were the largest factor in the August decline, dropping 5.0% from the month earlier.

Building permits, a key indicator of future housing activity, also dropped in August to an annual rate of 1.39- million units.

The Conference Board reported that its consumer confidence index continued to climb during September. The consumer confidence index rose to 128.6 in September, up from a revised 127.6 in August. The August reading was revised downward from the previously reported level of 129.1. Some economists believe that the steadily rising level of consumer confidence (the feel good index) has been buoyed by a strong employment market, low inflation in the economy, and wage gains. The Conference Board's report indicated that the consumers rating business conditions as “good” increased to 39%, up 1% from the previous survey. Presumably, 61 % of those interviewed have some reservations about how “good” are business conditions or failed to respond to the query. The report also said that interviewees who found employment “difficult to find” dropped from 17% in August to 16.6% in September. The report did not indicate how many of the non-respondents were employed.

The present situation index, however, declined to a reading of 155.5 in September from 156.1 in August. The consumer expectations index rose in September to a reading of 110.7 from a level of 108.7 a month earlier.

The present business expansion which has been underway since the first quarter of 1991 will likely continue in the months ahead. Although some weakness appears in various sectors of the economy, the overall strength of the economy is sufficient to tolerate temporary weakness in one or more areas and still expand at a moderate rate. We expect more of the same in the months ahead.

October 6, 1997Richard F. Maloney

AIC Investment Advisors, Inc.

440 South Street, Pittsfield, Massachusetts

Consensus National Futures and Financial On Line Index

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