Weekly Update: Detroit has it going on
This week in Detroit, I met several advisors who believe we are already in a recession, pointing to surprisingly weak retail sales over the last few months (more below) and noting the true unemployment rate is much higher than the reported figure (the participation rate is at a three-decade low). Although I disagree and say the bulk of the evidence I see weekly suggests no recession this year, the economic recovery has been weak and (in my opinion) the next recession will be mild, so whether or not we are in a recession now would seem to be splitting hairs. I also received a lot of pushback for saying any inflation worry is premature, as I am thinking interest rates will stay punishingly low for the saver for longer than people think. However, I was told to visit a grocery store. For sure, food prices look set to rise noticeably in the second half (more below), although there is offset from lower energy prices. (BTW, I had too much fun this week in Detroit. One advisor suggested I’m too young to recognize what was one of my favorite bands back in the day, and another said of course, you must work out every day. Who cares whether they were speaking sincerely, or just that the people of Detroit are terrific, I had a great time!)
Arguing against an imminent recession, there hasn’t been much buildup in inventory, business investment or consumer demand from which to shrink—recessions normally follow strong upturns, tax increases or credit tightening. Of course, there is the fiscal cliff. Encima Global believes an extension of current tax rates probably won’t come until December at the earliest, and expects the tax uncertainty and economic damage to increase at least through the November election, as it did in 2010, providing an argument for a 2013 recession. For my part, I can still report that when I survey end clients as I travel the country, over 90% of them don’t know what the fiscal cliff is. Gulp. But employers do. According to its anecdotal overview in the latest Beige Book (more below), the Fed suggests businesses are delaying hiring and other spending decisions while they wait to see if Congress acts to prevent the nation from confronting the pending tax increases and the massive spending cuts contained in last fall’s debt-ceiling compromise. A study for the U.S. Chamber of Commerce estimates if the Bush tax cuts are allowed to expire, 710,000 jobs will be lost. Gulp.
At the end of the day, the market trades on earnings. And so far this season, more than 80% of reporting companies have beaten expectations, with the average beat about 7%. So earnings thus far have been more “better-than-feared” than outright strong. (Ned Davis Research notes the current year-over-year gain in profits is below the norm for this many quarters past the recession low and that if the current profit cycle follows the path of the past six post-World War II expansions, the growth rate will continue to fall into 2103. Also, revenue growth is coming up short). The second half of election years has seen the market up in 17 of 21 cases (81%), with a median gain of 6% (that projects to 1,444 on the S&P 500). Might this election year be similar to 1936? It was four years after the stock market crash bottom of 1932, the economy was weak and unemployment reached 16.9%. There was a large disparity in income inequality, a key campaign issue of FDR’s, who won a second term in a landslide. That year, the S&P saw a second-half return of 15.8%. The election-year low has historically been late May/early June. And regardless of who won, the market rallied through September, and further if the incumbent won. Several of our sources suggest the market might melt-up if “business friendly’’ Romney is elected. (Either way, we win!?) Still, I look at Spanish bond yields climbing above 7% again, at negative bond yields in Germany and at record-low U.S. Treasury yields, even lower than at the worst of the financial crisis (even with the economy growing, record profits, and a more than doubling of the S&P from the bottom of the bear), and it makes my stomach uneasy. I’m looking at the window of opportunity, and I’m wondering if it’s beginning to close.
More signs of housing upturn A surprising decline in June existing home sales was a lone downbeat note in an otherwise strong week for housing. July’s NAHB/Wells Fargo Housing Market Index unexpectedly surged by the most since September 2002 to its highest level since March 2007, led by an 11-point gain in expected sales over the next six months, the most since November 1988. June housing starts jumped the most in seven months, also well above consensus and 60% above their cycle low in April 2009. Permits slipped, solely in the multifamily sector, but May was revised up. And year-over-year housing starts and permits continued to grow at solid rates.
June industrial production modestly surprises The above-consensus increase was led by the biggest gain in business equipment since December 2008, boding well for capex. On a year-over-year basis, production is up 4.7%, historically consistent with continued moderate output growth. New York’s Empire index also surprised to the upside, with activity picking up above forecasts. But that was offset somewhat by the Philly Fed’s regional gauge, which rose but still remained in contraction territory. May’s business inventories rose above consensus, but the inventory-to-sales ratio held at low levels, suggesting no negative production impacts.
See you in September The markets reacted positively to Fed Chairman Bernanke’s somber tone during this week’s testimony before Congress, even though he didn’t discuss any further easing options, lowering the probability of significant new easing initiatives at the July 31-Aug. 1 FOMC meeting. The Fed will not have the July employment report at that meeting, but it will have two more employment reports before the Sept. 12 meeting, which is when observers believe it may act.
Are consumers touching that window? June retail sales were much weaker than forecast, sliding a third straight month even if autos and gas are excluded. The slowing economy at home and worries over the situation in Europe are likely weighing on both consumer spending and sentiment. Ned Davis notes the trend in retail sales peaked in August 2011 at 8.7%; the current year-over-year growth rate is 4.7%. At the start of three of the last four recessions, retail sales growth was 4.3% or higher. In each of the last four cases when sales growth peaked above 8% and then fell below 3%, we had been in, or were about to be in, a recession. Gulp.
Bummer summer Bernanke told Congress the expansion is slowing, job growth is declining and consumer spending is decreasing despite the tailwind of lower energy prices. His testimony coincided with the late June-early July Beige Book, which indicated activity grew at a modest-to-moderate pace, slightly less positive than the previous survey, with growth slowing in the New York, Philadelphia and Cleveland districts. The Conference Board’s leading indicators also fell 0.3% in June, the most since last September, disappointing consensus. When housing is being described as the economy’s one bright spot, it’s no wonder the economic recovery is weak.
It’s too early to worry about inflation but … June’s headline consumer prices were unchanged vs. expectations for an increase, and the core rate reflected continued moderation. However, soaring corn, wheat and soybean prices arising from the worst summer drought since summer 1988 (nearly three-quarters of the continental U.S. is dry or in drought as the National Climactic Data Center reports the country is suffering from the warmest 12 months through June since records began in 1895) are expected to start working their way into prices soon. ISI Global estimates that for every 10% gain in grain prices, food prices will climb 0.3% with a lag of about 12 months.
My boys seem OK A study found that boys account for three-quarters of Ds and Fs as their advantage in math and science over girls is nearly gone and the writing gap is widening—11th-grade boys now write at the same level as 8th-grade girls. Some colleges are even lowering admissions standards just to admit a decent number of men. Even so, men make up just 40% of college students. The performance gap in graduate school is even higher. This isn’t just a U.S. problem; boys are falling behind in all 35 member-nations of the Organization for Economic Cooperation and Development.
Don’t tell the athletes London’s Olympic hardware is the biggest and most expensive ever produced. The medals weigh almost 1 pound. The ribbons are purple—the royal color—because 2012 is the year of the Queen's Diamond Jubilee. The bronze metal is worth $3, consisting of 97% copper, with the rest being tin and zinc. The silver medal is worth $325, fashioned from 92.5% silver and 7.5% copper. The gold medal is worth $660, but it only consists of 1.34% actual gold, with 92.5% being silver. If it were made of pure gold, it would be worth $21,200. The price of gold has risen 90% since the 2008 Olympics in Beijing.
Did I mention dividends? Dividend growth has been the best-performing factor in year-to-date stock returns and one of the most consistent investing strategies, outperforming other factors every month this year except June and in eight of the last nine quarters, Bank of America says. It lets you put your feet up during a bummer summer.