A Time for Analysis
--- by Guy Baker
Thanksgiving is always a time to assess the year retrospectively and gauge whether or not there are any things that need to be adjusted or changed for the coming year. It is also a time to do tax planning and budgeting. The jury is still out on 2009 but if all the economic news holds steady, it has been quite a ride.
You may have seen the third quarter (3Q) Gross Domestic Product (GDP) was revised downward to +2.8% from 3.5%. Even with this adjustment, this was the first positive quarter since June 30, 2008. The overall downward revision was due to small revisions to net exports, personal consumption, and commercial construction. Government spending was revised up slightly. The largest positive contributions to the real GDP growth rate in 3Q were personal consumption, inventories, and government. The weakest components of real GDP were international trade and commercial construction.
While downward adjustments are disappointing, it was good to see corporate profits continued on the upswing. Profits were up 10.6%, which was the third consecutive quarterly increase. It is hard to evaluate how much of this is due to economic activity as opposed to cost cutting which has seen reductions in jobs and increased unemployment.
It is not particularly encouraging to discover more than 90% of the 3Q profit increase is attributed to financial enterprises. That means only a small segment of the gains came from the non-financial sector. With unemployment hovering around 17% (real and implied), this is not particularly heartening.
The economy did see consumption reach its highest level in more than 12 months. According to the Conference Board Consumer Research Center, personal income was up 0.2% while consumer consumption increased +0.7% in October. This was the fifth increase in the last six months. According to the Gallup Organization, economic confidence has improved to -29 from -48 in April. While, we may not see a robust Christmas season, things do seem to be improving, albeit slowly.
There are three factors playing in the improvement. First, the saving rate is up to 4.4%, versus 2.9% a year ago and 1.7% two years ago. Second, the stock market has risen substantially. Third, consumer (non-mortgage) debt has fallen 5% versus the peak in mid-2008. The improvement in household balance sheets has been accompanied by a deterioration of the government’s balance sheet, but this problem, is not likely to derail the recovery any time soon. This revival in spending can no longer be attributed to “cash for clunkers.” “Real” (inflation-adjusted) consumer spending in October (which was projected to be artificially low because the clunkers program ended in August) was up at a 2.6% annual rate versus June, which was before the clunkers program started. Focusing on “cash” spending (which means excluding the imputed rent the government says homeowners charge themselves), the growth rate would be even stronger.
On the inflation front, overall consumer prices are up at a 2.7% annual rate in the past six months. This warning sign suggest the Federal Reserve monetary policy is too loose and interest rates will need to rise sooner than hoped or expected.
After seeing a two-month lull in new home sales, the market surged in October, resuming the upward climb we saw start in the spring and early summer. Sales have increased 30.7% since their January low and for the first time since 2005, new home sales are up on a prior year comparison basis. It is easy to attribute this increase to the new homebuyer tax credit (extended till mid 2010), but some credit must be given to increased affordability of homes (a combo of lower prices and low fixed mortgage rates) are the main factors. Over the next few years, the pace of new home sales should gradually return to its long-term trend of about 950,000 new homes per year. New home inventories have sunk to a 38-year low, despite the large increases in the US population over the same time frame. Even at the peak (2006), builders were working on 336,000 new homes inventory. Now there only 103,000 unsold homes still under construction.
Orders for durable goods fell short of consensus expectations in October. However, the underlying trend remains gradually upward. Orders have generally been rising at about a 5% annual rate. But new orders have not gone up nearly as projected based on the ISM Manufacturing Index, which has averaged 61.4 over the same time frame (an index level of 50+ signals expansion). Many economists suggest this will happen next year.
Unemployment insurance fell 35,000 last week to 466,000. The four-week moving average is below where it was a year ago. Meanwhile, continuing claims for regular state benefits declined 190,000 to 5.42 million.
Bottom Line: So far, if this is a sustainable recovery, it appears to be "two steps forward – one step backward." It could take another year or so for the economy to move steadily ahead. Think about it, we are about to move into another 2000 decade. But with healthcare and Cap and Trade still high priorities for this administration, it is hard for me to have any confidence this recovery is sustainable. Couple that with China’s repeated threats about the debt; we may be in for a bumpy road.
THE MARKETS
November saw mixed results for the major indicators. The Dow Jones Industrials [+5.31%; +17.48%], the NASDAQ Composite [+4.34%; +35.60%] and the S & P 500 [+6.42%; +20.87%] all rose significantly during the month. There was some give back in the last week, but that was to be expected due to the concerns about Dubai, one of the United Arab Emirates. Fortunately, for the world markets, their current status is not truly impactful because they have virtually no oil. Will the Dubai problem impact a potential year-end rally? Much will probably ride on what happens with Obamacare and how the markets will perceive the damage if it passes.
MORE INFORMATION THAT YOU REALLY WANTED TO KNOW
- October retail sales were higher than expected--up 1.4% from the previous month--but September's decline was worse than previously anticipated (-2.3% instead of -1.5%).
- Higher food and energy prices pushed wholesale inflation up 0.3% in October. So-called core inflation at the wholesale level saw its biggest decline in 3 years, down -0.6%. Energy also was responsible for a +0.3% increase in inflation at the retail level in October. Cars contributed to the increase; prices for used cars and new cars were up +3.4% and +1.6% respectively. On an annual basis, consumer inflation is down -0.2%, though core inflation, which excludes energy and food, is up +1.2%.
- Industrial production continued to rise in October, though at a much slower pace than the previous three months. Cooler weather pushed up output at utility companies by 1.6%, which accounted for almost all of the 0.1% increase in overall industrial production. Factory output contracted by 0.1%.
- After four months of staying level, housing starts fell 10.6% in October--the biggest decline since January. That put new residential construction almost 31% below last year's level. Building permits fell 4% during the month.
- Six of the ten leading economic indicators measured by the Conference Board were up in October, resulting in a 0.3% increase in that index (its seventh consecutive gain). The positive factors were interest rate spreads, stock prices, jobless claims, hours worked in manufacturing, money supply and new orders for consumer goods. The negative indicators were consumer confidence, building permits, vendor performance and new manufacturing orders – non defense.
- The Mortgage Bankers Association said a record 14.41% of home loans were either behind at least one payment or were in foreclosure during the third quarter--the highest level since the survey began in 1972. Of foreclosures begun in the third quarter, 33% were on prime fixed-rate loans. Florida, California, Arizona and Nevada continued to have more than 40% of all foreclosures.
- Hoping to mute public outcries over its proposed employee bonuses, Goldman Sachs announced it will contribute $500 million to provide business education and capital for small businesses.
The U. S. dollar neared record lows against the Japanese Yen (¥), but managed to stay just under the $1.50 level against the Euro (€). There's not much to be optimistic about as far as the dollar is concerned, and this is likely to worsen in months ahead, sending gold and other commodity prices even higher.
FINANCIAL FACT OF THE WEEK
Fortune Magazine (www.fortune.com) reported that 74 corporations in the S&P 500 index have cut $48 billion in dividends in 2009 -- the highest amount ever -- and Standard & Poor's senior index analyst Howard Silverblatt forecasts average payouts will fall by 36% compared to last year. That would be the worst annual percentage decline since 1938.
But dividends are not dead. Some companies maintained or raised them in the past year, indicating their payouts can survive even the worst markets. In fact, dividend investing remains a sound course amid market turmoil. Ned Davis Research shows that since 1972, companies that increase or begin paying dividends have actually returned 9.5% a year compared to the rest of the S&P 500, soundly beating their 6.8% return annually.
Merry Christmas. Watch for our Year in Review summary in early January.
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