29 Aug 2003 Progress Continues, But Slowly

Yesterday, the Commerce Department reported that the American economy grew faster in the second quarter than previously thought.  U.S. gross domestic product grew at a seasonally adjusted annual rate of 3.1%, revised from an earlier estimate of 2.4%, following a 1.4% rate in the first quarter.  The biggest factors in GDP growth were increases in consumer spending, up 3.8%, following a 2% increase in the first quarter; business spending, up 8%, following a 4.4% first-quarter increase; and the largest jump in government defense spending since the early 1950s, up 45.9% following a 3.3% decrease the quarter before.

The consumer continues to provide most of the push for this economic recovery, but, business spending is starting to improve.  The 8% jump in purchases of equipment and software was the biggest in three years.  Computers and software are usually the first investments businesses make because they increase productivity relatively quickly.

Intel, the world’s largest semiconductor manufacturer gave further credence to the business spending story when it raised its third quarter sales growth forecast to as much as 20% on expectation that demand for microprocessors will rise.  But when pressed on whether the increase signified the long-awaited recovery in tech spending, CEO Craig Barrett said “we’re not going to forecast a recovery in the IT sector yet . . . we’ll look at one quarter at a time.  It will take a couple of quarters of above average growth for us to forecast resurgence.”  But Andy Bryant, the company’s chief financial officer was more outspoken saying that “the economic tide is rising a little bit,” adding that sales of processors were “unexpectedly strong.”

Part of the support from consumer spending has come from the record mortgage re-financings of late.  That historic phase is coming to an end as interest rates rise.  The Mortgage Bankers Association of America said today that it’s Market Composite Index, a measure of new applications, fell by 13.3% to 638.6 on a seasonally adjusted basis from 736.7 the week before, the third consecutive decline. That’s the lowest reading since June 2002, according to the Wall Street Journal.

More striking was the 21.3% decline in the Refinance Index to 2169, also a 14-month low. The surge in mortgage refinancing was one of the country’s longest, induced by historically low interest rates.  And in turn it became an important stimulus during slow economic times by providing homeowners with extra cash to spend.

The housing market is also showing signs of slowing.  Earlier this week, the Commerce Department said sales of new homes fell by 2.9% in July after rising to a record rate in June.  And while sales of existing homes shot up last month, according to the National Association of Realtors, that organization’s chief economist predicted that the market had finally reached its peak.

With refinancing waning, a major source of the consumer’s spending power the last few months, consumer confidence numbers are now more important than ever.  For the consumer to keep spending, confidence in the economy must improve.  On Tuesday, the Conference Board reported that its consumer confidence index grew more optimistic about prospects for jobs and earnings over the next six months.  The index rose from a revised 77 in July to 81.3 this month.  While optimistic about the future, survey respondents were less sanguine about current economic conditions.  The index measuring sentiment about the current economy fell to 61.6 from 63.  Today the University of Michigan announced that their sentiment index fell more than expected to 89.3 from 90.9 last month.

For the consumer jobs are now center stage.  And just like the other aspects of this economy, recovery on that front is likely to be slow.  On Wednesday, the National Association of Manufacturing inWashingtoncalled the recovery for manufacturing the “slowest on record since the Federal Reserve began tracking industrial production back in 1919.”  It pointed out that 2.7 million manufacturing jobs have been lost over the past 36 months, according to Bloomberg reports.

But, the tide may be turning.  While the economy is not yet creating new jobs at a healthy rate, the pace of firings is slowing.  On Thursday the government reported that the number of Americans filing for unemployment totaled less than 400,000 for the fifth week in a row indicating to economists that the job market is expanding rather than contracting.

Economist Kevin Harris, quoted by Bloomberg, says that “some parts of the economy are doing really well.  Wal-Mart for example will hire.  Everybody else is going to wait until next year[‘s] . . . new business plan.”  Wal-Mart said that it plans to create jobs as it opens as many as 210 SuperCenters, 20 Neighborhood Markets, and 40 Sam’s Clubs stores this year.

Personal income and spending continue to rise as reported today by the government.  Disposable income, or the money left over after taxes, rose 1.5% in July, after increasing .4% in June.  The reduction in income tax rates accounted for 1.3 percentage points of the 1.5% increase in disposable income according to Bloomberg.  Spending on durable goods had the largest impact on overall spending with a 2.1% increase following a 1% increase the previous month.

Announced moments ago, the Chicago Purchasing Managers index came in well above expectations at 58.9 and represented the fourth month in a row of expansion.  When the index is over 50 it indicates that orders and production are expanding.  In fact, they are expanding at an increasing rate because inventories are so low relative to consumer spending and the lower dollar making goods cheaper overseas.

The week’s economic news is in the books and the markets have reacted pretty well to the news.  The S&P 500 is up just under 1% for the week.  Short treasuries are unchanged, long-term treasuries are up about 1% and the dollar is down modestly.  News from the Middle East and the bellicose talk from North Korea failed to upset markets as they have in the past.  If there is a trend developing it is one of increasing stability.  The volatility of the S&P 500 continues to fall.  The 10-day moving average is now at 7.4%.  Those lows have not been reached since the late 90’s.  Even the volatility of the Nasdaq 100 has fallen dramatically.  The fact that volume falls dramatically in August accounts for some of the falling volatility, but these levels are well below the prior four August periods.  As volatility falls investors become more confident and comfortable with increasing their allocations to stocks.

The recovery of both the economy and the stock market appear to be well underway.  The stock market anticipated economic recovery in the period of March through mid June, but has largely marched in place since then.  But new advances are coming.  Earnings season picks up again in September and October.  And by the time it is apparent that this economy is rapidly creating jobs, the stock market will likely have advanced again in anticipation of that growth.  If you have funds and are thinking of adding them to the market, conditions appear very good over the coming months.