The Good News: The Economy is not Deteriorating
by Guy Baker
Well the good news, if you want to call it that, is that the economy is not deteriorating. It seems to be holding steady. So that is definitely a plus. As a result, most of the economic data for the last week was positive.
Here are some examples:
- The ISM Manufacturing Index jumped to 52.9 from 48.9 in July
- Durable goods orders were up 4.9% - this was the biggest gain in the last two years
- Consumer confidence rose more than expected to 54.1 from 47.4 in July
- New-home sales increased 9.6% in July. This is the 4th consecutive monthly gain
This is the first time since January 2008. This is very positive because it is a leading indicator that the economy is rebounding. Unfortunately, the second-quarter GDP report showed a decline of -1.0%. Consumer income and spending were flat in July. However, corporate profits were up again (that’s two consecutive quarters) after having declined continuously for the past two years. The stock market does not go up if corporate profits are down. So this is good news if profits continue to increase.
Government statistics showed the nation's savings rate declined again last month. While this is not particularly a good thing, it does suggest consumers are coming back into the marketplace. We have all heard the US economy is a consumer driven economy, so if consumers are more confident and are starting to buy again, this is another indicator the recovery may in fact be starting. Just remember, consumers are fickle.
Another point to remember, government spending has been inserted in the place of personal consumption. Government spending is what has kept the economy going. What will happen when the consumers are fully engaged? IF the government does not cut back their spending, high inflation rates are going to occur. What are the chances the pace of government spending will reduce once individuals re-enter the market place? If indeed, the government continues to spend, high inflation is almost a certainty.
Finally, it should be noted President Obama re-appointed Ben Bernanke for another 4 year term as Fed Chairman. Probably an easy call. He will certainly have his hands full in the months to come.
THE MARKETS
The markets continue to react to the “good news.” Despite the torrent of mixed economic indicators, the markets didn't react much. Even Bernanke’s re-appointment didn’t make much of an impact. The Dow [+0.40%; +8.75%], the S & P 500 [+0.27%; +13.95%], and the NASDAQ Composite [+0.39%; +28.65%] all moved slightly higher.
The Dow Jones Industrial Average is up 46% since March 9, when the world itself seemed to be coming to an end. In the entire 113-year history of the Dow, only six rebounds have actually been more robust. But is this bounce-back reason to be optimistic? In fact, it may be reason to be cautious.
In March, stocks were trading at 11.7 times average earnings over the previous 10 years. That put the market at its lowest valuation since January 1986. Today, stocks are selling at 18.4 times inflation adjusted earnings. The long-term average has been 16.3 times earnings. One has to think the pendulum has swung too far the other way.
A recent analysis of P/E ratios for the S & P 500 showed the average was now above sixteen for the first time in many months. Perhaps, the markets can hold onto the impressive gains attained so far this year. But remember, October is always a month for surprises. So it would be good to watch awhile longer, in my opinion, if you are thinking about jumping back in.
Dividend yields for the S & P 500 have drifted lower as the capitalization values have increased. There is still a negative difference between T-Bill yields and dividends for the S & P 500. But the gap is getting smaller. Historically, the difference would be positive – T-Bills would be higher than the dividend yields. But it appears the Fed policy is set to virtually have no return on T-bills for the near term.
So exactly why is the market moving? Some safe money investors could be now realizing, their T-bill and CD investments are going to stay flat for sometime to come. With more than $3 trillion sitting in money-market funds, there is a lot of capital waiting to move into the something.
We saw mortgage rates stay flat and treasury yields decline this past week. So the news on interest rates is there is no news. The yield curve is expected to stay status quo through the end of the year. The price of crude oil jumped at the end of the week while gasoline prices dipped a little. Usually, during the summer months, between utilization and supply, the price of gasoline rises. Nobody is expecting oil prices to change much if the economy keeps steady. For oil prices to rise, the markets will have to rise.
Benjamin Graham, in his classic book "The Intelligent Investor," wrote "the investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances." It is all about time horizon. The greatest enemy to successful investing is emotion. According to Graham's definition you aren't an investor at all if you are bailing when the markets slide.
As a side note, there is nothing wrong with dollar-cost-averaging back into this market. But it would be hard to suggest buying 18.4 time earnings stock just because the market has risen. Stocks do not become safer when the prices rise. If that were true, then investors who were clobbered in 1929, 1972, 1999, 2007 and every other market bubble in history would not be licking their financial wounds.
FACT OF THE MONTH
Where would you guess the US ranks among all countries for the self employed? The Center for Economic & Policy Research study showed the U.S. is among the lowest of the 22 countries analyzed. The US was 20th among 22 countries for the number of self-employed persons as a percentage of total civilian employment. Here are some of the results:
| Greece |
35.9% |
Spain |
17.7% |
Britain |
13.8% |
Germany |
12.0% |
France |
9.0% |
U. S. |
7.2% |