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Is the economy falling into recession or is it merely stalling? The S&P 500 is off its April high by 12% while the rally in the 10-year US Treasury has driven yields to 2.55%, the lowest in 17 months. Yesterday the government’s leading economic indicators showed an increase of .1% in July provides hope that the economy is merely in a stall. But jobs, housing, and even manufacturing which has been a bright spot for the economy were more worrisome as they each declined this week. While the economic numbers were mostly negative this week, there is a bright spot. Intel’s acquisition of security software maker McAfee brings the August total of announced takeovers to more than $175 billion. Acquisitions are on a pace for August to surpass March as the biggest month for deals this year, according to Bloomberg. The month is typically the slowest.

The mood on Wall Street has brightened considerably over the last couple of weeks. With only one down day in the last 12 (not counting Tuesday’s decline of .06%) the S&P has rallied 7.5% so far this September, following the worst August since 2001 losing 4.7%. September is traditionally a bad month for stocks as companies begin warning of earnings disappointments for the third quarter and mutual fund managers return to stir their pots as they return from summer vacations.

Whatever economists ultimately label this period in American history, no doubt fear will play a large part in their description of it. Confidence numbers among consumers, investors, voters, and businesses hit all-time lows in 2008 and are only gradually coming back. The declines in economic indicators this summer sparked new fears, including a return to recession, even deflation. The new wave of trepidation drove many investors out of stocks once again and back into the short-term safety of money markets and short Treasuries.

Political strategist James Carville won the election for Bill Clinton when he turned the campaign’s focus toward the economy to unseat President George H. W. Bush who was considered unbeatable because of his successful foreign policy. An article in the Capital Journal Section of today’s Wall Street Journal by Gerald Seib sums up the problem facing not only the Democratic party this election cycle but the economy in general. “Fact One: The unemployment rate is the most important of all leading political indicators. Fact Two: If the August unemployment number to be announced Friday tops 9% [it increased from 9.5% to 9.6% last month] the jobless rate will have been above that level for 16 straight months. Already, the U.S. is mired in the longest such stretch of 9%-plus joblessness in more than a quarter of a century.”

The 10% rally in the S&P 500 beginning in early July abruptly turned this past Tuesday as the Fed announced a small downgrade in their assessment of the recovery and as a Chinese government report suggested growth was slowing in that economy. The US recovery has been largely attributed to exports which will decline if China and the global economy drift back into recession. The three-day decline in stock prices this week erased 3.8% from the 10% rally. Treasuries on the other hand continued their multi-month advance as the Fed said they would replace maturing mortgage bonds held on their books with two to ten-year Treasury bonds. The Barclay’s 7-10 year Treasury index is up 3% since early July. 

The Great Recession, now in its 33rd month, drags on relentlessly and painfully as headlines such as today’s unemployment number perpetuate the gloom. The US economy lost more jobs in July than was expected and the unemployment rate remained fixed at 9.5%. But beneath the din, there are substantial reasons for hope of improvement.

The combination of strong earnings reports and guidance from giants like Alcoa, Intel, Microsoft, Ford, UPS, 3M along with better-than-expected economic data in Europe cheered equity investors this week. Despite the enactment of sweeping economic reform legislation, potential tax hikes promised by the White House and comments from Fed chief Ben Bernanke that “the economic outlook remains unusually uncertain” the rally continued. 

Economic data reported during this holiday-shortened week was particularly light; perhaps facilitating the market’s rebound of 4.5%. Global markets rebounded as well as investors realized the world’s economy was not cliff-bound. Europe’s credit implosion has dampened growth, but evidence so far indicates it will not stall the recovery.

Paul Krugman in a column in Monday’s New York Times shook up the financial press and investors alike with his claims that “The Third Depression” may be upon us because of the “triumph of orthodoxy” evidenced in the G20’s endorsement of deficit reduction. Krugman a liberal economist and staunch Keynesian believes that government stimulus is the only way to create jobs, and that belt-tightening at this time would be disastrous. Unfortunately, the bond and stock markets seem reflect a similar fear at present with the benchmark 10-year Treasury at just over 3%, a level not seen since April 27, 2009, and the S&P 500 Index sliding to a nine-month low yesterday.