Near-Term Slowdown, But Economy and Bull Market Remain Healthy

Indications are that a slowdown is in the cards for this quarter and for the first quarter of next year, but that does not mean recession must follow, as some more pessimistic economists suggest.  Indeed there are many reasons to expect a significant pickup.  Productivity, the driver of this powerful economy remains alive and well.  Productivity not only keeps our economy growing without inflation, it is vital for the remain competitive in an increasingly competitive global economy.  Yesterday, the government reported that Non-farm Productivity was up a whopping 4.1% for the third quarter and well ahead of last quarter’s 2.1%.  The increase more than offset the 3.6% increase in hourly compensation, so unit labor costs fell 0.5% during the quarter.  

Those economists who worry about recession point to consumer confidence drops of late as well as slowing retail sales, particularly those of WalMart and other low-price retailers.  But increases in productivity have increased real pay per worker increasing his purchasing power.  As Ed Yardeni points out:

“In theory, productivity is the key driver of consumers’ purchasing power.  In fact, it is highly correlated with real pre-tax compensation per payroll employee as predicted by theory.  Since 1960, this broad measure of purchasing power has grown at the same pace as productivity. During the 1960s, both rose 3% per year, on average.  During the 1970s, 1980s, and the first half of the 1990s, both increased only 1% per year.  Since 1995, the pace is back to 3%. This largely explains why consumer spending has been so remarkably resilient and relatively steady over this volatile period for the economy.”

The Business side of the economy looks even stronger.  Both ISM Manufacturing and Non-manufacturing were up October much stronger than expected.  It appears likely that corporate earnings growth will finish above 10%, which will mark the 9th consecutive quarter of double-digit earnings growth for the S&P 500.  According to First Call, since 1950, there have been only 3 other instances of 9 consecutive quarters of double-digit earnings growth: 2Q72 – 3Q74, 2Q87 – 2Q89, and 4Q92 – 4Q95.

Through October 28th, 341 companies in the S&P 500 index have reported earnings for the third quarter. Of these 341 companies, 68% have reported earnings above analyst expectations, 13% have reported earnings in line with analyst expectations, and 19% have reported earnings below analyst expectations.  Since 1994, 59% of companies beat the estimates, 21% matched estimates, and 20% missed estimates.

Earnings season is almost over so market volatility will likely decline in the weeks ahead.  As mentioned, we expect the next couple of months’ market movement to be locked in a trading range as investors’ uncertainties regarding inflation, high heating costs, job creation, etc. are answered.  After that we believe the market will begin to anticipate a growing national economy as well as a selectively growing global economy.  As the Fed finishes its rate increases stronger equity performance will likely follow.