Still Economic Decline... But At A Slower Pace!

The headline above has indeed been the characterization depicted by the economists monitoring the components of such measures as our gross domestic product. In turn it became the mantra of many stock market analysts over the past calendar quarter. The apparent consequence of those overtures was a robust market performance that found itself leveraging off a market bottom from back on March 6. Quarterly performance in the second quarter for major indexes found the Dow Jones Industrial average up 11.01%, the technology laden Nasdaq up 20.05%, and the S&P 500 up 15.2%. This latter index actually posted its best quarter since 1998. The consequence of this movement left only the Dow with a still negative year to date return of -3.75%.

So half the year is behind us and as the golf enthusiasts would say... we're heading into the back nine. For the non golfers our analogy is the following, all things considered we played a pretty good front nine holes and we need to keep the momentum going into the back nine to really get a good score. That's what both the economy and investment markets would like to see. As might be the case with the topography of a golf course we could be in for some challenging time.

The third quarter began with some disturbing news on the employment front. Employers cut a higher than expected 467,000 jobs in June and the unemployment rate rose to 9.5% which is the highest rate since August 1983. There had been hope for some continuance of the slow but steady moderation in job losses that began several months ago and indeed the expectation had been for a figure in the vicinity of 350,000. Clearly the jump was a major disappointment and the thinking remains that we will approach, if not exceed, the 10% unemployment figure.

While the U.S. economy has lost approximately 6.5 million jobs since the recession began in December 2007, an even more disturbing figure is that there has been a significant increase in the number of "underutilized workers." This represents not only those people on the unemployment ranks, but those who have used up all benefits, those who have stopped looking through sheer discouragement, and those who may only be working part time. This entire category of people has doubled from fifteen to thirty million.

Manufacturing has been posturing for an inventory based recovery for the balance of this year. In support of that strategy The Institute for Supply Management reported that manufacturing, which accounts for 12% of the economy, shrank in June at the slowest pace in 10 months as it appears that inventories are approaching the levels where production may have to pick up. As for corporate profitability the earnings season begins this week as we write our newsletter. There is some dichotomy in the strong performance indicated above for the S&P 500. While that market valuation increased substantially, exactly one half, or 250 of the companies in the index, actually had dividend decreases. This was the second highest number of decreases on record in any quarter, only exceeded by 272 companies in 1958. Corporate financial strategy appears to remain defensive with the conservation of cash high on the agenda. Dividend reduction supports that objective until there is a clear sign of improvement in profitability.

May U.S. existing home sales, the latest available as of this writing, rose 2.4% to an annual rate of 4.77M homes per year. Distressed or foreclosure related sales accounted for 33% of that activity with the consequence being that the median home price dropped 16.8% from a year ago. It is widely accepted that stabilization of the housing market is an absolute requirement to firm up the economy and once again get on the path to growth. There are many components to achieving that stabilization such as working down home inventories, reversing price declines, more availability to mortgage financing, and reducing mortgage defaults to name a few. As to the last point, a significant test will be when the perceived overhang of a second wave of mortgage resets are scheduled to begin later this year. That will indeed be a true test if we are on the path to recovery.

It is also clear that consumer spending remains a most important ingredient to economic recovery. Accordingly, there was some disappointment when the Conference Board reported a decline to 49.3 from 54.8 in the consumer confidence index. Consumers reflected more pessimism in June about their present status and the future with only 17.4% surveyed indicating that they expected more jobs to appear in the months ahead. Another interesting observation about the consumer comes from The Bureau of Economic Analysis Monthly Personal Income and Outlays Report for May. It indicated that a large proportion of the stimulus money that went out this past May was saved rather than spent. That was not the intent of the government but reflects the change in attitude with the basic consumer. We now have a U.S. savings rate just shy of 7% which is the highest since 1993. While we have traditionally had one of the lowest savings rates among developed countries we do need to see the consumer spending more to get the economy back on track.

Recently the Federal Open Market Committee stated that the pace of economic contraction is slowing, the theme we have been hearing from many economists as we indicated at the outset of this article. So it remains the same headed into the second half of the year. Additionally, the Federal Reserve indicated that they would employ all available tools to promote an economic recovery. They will, however, need continued assistance from the administration and Congress to achieve that objective.

So the economy is ready for its own back nine as we start the second half of the year. No doubt it will be fraught with its own share of sand traps, water hazards, and abundance of narrow tree lined fairways all in its own economic form. Good luck with your game!