News indicates shakiness

Perusing the newspapers this morning it is difficult to feel super positive about the economic recovery. Before taking these in turn let’s establish the appropriate context for evaluating these stories.

Context: The financial markets rose very strongly from March thru August, racking up gains that normally take 5-7 years to accumulate. It was clear that the financial markets were pricing in an end to the recession and a return to economic growth. What investors were awaiting was the proof. That proof was to come via the third quarter earnings season. Profit reports have been rolling in now for three weeks. While the results have been good they have not been screamingly good. In fact, with the exception of several companies, most notably Apple, the reports have been in line with expectations. But more importantly, the general out performance seems to have been priced into the markets. The Dow Jones Industrial Average is up 1.75% since the earnings season kicked off. But the S&P 500, a much broader measure of U.S. businesses, is up a tepid 0.6% since the end of the third quarter. Lastly, the NASDOG is down 0.3%. Whew! So what’s going on? Why aren’t these above average earnings reports leading to outsized gains?

First of all, let’s examine something that old skool, dyed in the wool economists hate…soft evidence.

The American Mood:

A new Wall Street Journal/NBC News poll finds that the U.S. citizenry is getting depressed about the economy. Specifically, 58% feel that the economy is still likely to get worse (!). While only 29% said that they felt the economy had hit bottom. Very interestingly, 64% said that the rise in the DJIA didn’t effect their views of the economy. This is evidence of why the market has not surged despite the improved earnings performance of U.S. businesses. Only 42% of those interviewed feel that the economy will get better in the next year.

Analysis: Because consumer spending makes up 70% of GDP, a depressed and worried consumer bodes ill for the economy. At a certain point people have to trust the evidence around them: an improving business climate and an improving wealth engine, i.e. the stock markets. However, the big issue here is the spectre hanging over most American’s heads: high unemployment rates and continued stories of layoffs. Additionally, the country has been at war for 8 years, double the length of World War II. Additionally, many Americans continue to be living under very austere conditions relative to memories of previous good times. The problem is that if the U.S. consumer looses faith in the data then they will stop spending. Ironically, the very thing the U.S. consumer fears will be triggered by their fear: a declining economy. This is not good.

* Note: the WSJ/NBC poll has a margin of error of +/- 3.1%. This is a high margin of error. So there is a chance that this poll is not really reflective of mood. However, my opinion is that this poll is very important at this critical juncture in the economic recovery.

GMAC soaks cash up:

The U.S. government and GMAC are in discussions to infuse the massive auto lender with its third round of cash. Between $3 – $6 billion of fresh support is being negotiated in exchange for an additional U.S. government ownership stake. As it stands, the Feds already own 35.4% of GMAC.

Analysis: This piece of news is important for two reasons. One, it is evidence that financial companies are still shaky and barely able to stand on their own feet. Two, the U.S. “cash for clunkers” program was a temporary demand stimulus and the U.S. auto industry is still struggling. GMAC facilitates the purchase of autos. For the company to be struggling is an indication of both defaults, but also low transaction volumes due to low auto purchases. This is not good.

Consumer (Un) Confidence:

October’s consumer confidence sits at 47.7 and is the second fall in two months. One of the ways the Conference Board’s data can be parsed is to look at what is known as the “present situation index.” That number fell to 20.7 and is the lowest number since February of 1983 – during the heart of the 1982 recession. This low number is attributed to the poor labor market.

Analysis: This is simply further evidence of the shakiness of the U.S. consumer.

*****

Now, what if there is further war in the Middle East? Exactly. It pays to be cautious right now.

Let’s be careful out there!

Jason