07 Dec 2001 Recovery Ahead? – The Market Believes

In April of 1991, the National Bureau of Economic Research declared that a recession had begun eight months earlier in July of 1990.  They later announced that same recession had ended in March of 1991.  The recession was actually over and recovery in progress before the recession was officially declared.  The same official body recently declared that our economy entered a recession in March of this year. The economy contracted at a 1.1% annual rate between July and September as consumer spending slowed, business spending slumped, and companies slashed inventories. It is the largest decline since the first quarter of 1991, at the end of the previous recession. 

The biggest economic news this week came on Tuesday when the National Association of Purchasing Management announced that their non-manufacturing business index increased to 51.3 last month (an index above 50 suggests expansion) after plunging to a record-low 40.6 in October.  You will recall from earlier briefs NAPM, in my estimation is one of the best measures of the economy’s present and future health.  One month does not make a trend, but the strength of the NAPM index’s move is very encouraging, given that service or non-manufacturing businesses account for more than four-fifths of our economy.  AOL Time Warner Inc.’s America Online unit added 1 million subscribers after the attacks.  WalMart and other leading discount stores set some weekly and monthly sales records.

The day before the good news on the service sector, NAPM also announced that their manufacturing index climbed to 44.5 last month from 39.8 in October.  While conditions improved, a reading below 50 still signals contraction, and the index has stayed below that level since dropping to 49.9 in August 2000.  But, just as in the service sector, the manufacturing index improved in November at a better-than-expected rate.  The market ran with both of these reports as investors took them as signs of a recovery beginning soon.  Autos sold at a record pace in October, and Ford and General Motors are considering boosting production at the start of next year.  Lockheed Martin, the biggest defense contractor, in October won a contract valued at as much as $200 billion to develop the Joint Strike Fighter, the most expensive program in military history.

Consumer spending is a critical measure because the consumer represents fully two thirds of the economy.   This week, the Commerce Department reported that consumer spending increased a record 2.9% in October after falling 1.7% in September.  The pace suggests that consumers may limit the degree to which the economy shrinks in the fourth quarter.

Today, the government announced that the November jobless rate rose to 5.7%, the highest in more than six years, as 331,000 more jobs were lost.  The increase was more than the 5.4% economists expected.  The unemployment rate is up 1.4% since March, more than the 1.3% increase in the first eight months of the 1990-1991 contraction and less than the 1.8% rise in the comparable period for 1981-1982.  Since the recession began in March, the economy has lost 1.2 million jobs, the Labor Department said.  That compares with 1.4 million lost in the first eight months of the 1990-1991 recession, when the workforce was smaller, and a 1.1 million decline in the 1981-1982 recession.  Unemployment will likely to continue to rise as companies trim hiring plans.  The number of U.S. companies planning to add workers in the first quarter declined to 16%, the fewest in 18 years, from 27 percent for the first quarter of 2000, according to a survey of 16,000 employers by Manpower Inc.

Bear in mind that unemployment is a lagging indicator of the economy.  Businesses wait for actual improvement in orders before hiring new employees.  The market does not.  It anticipates recovery, by looking to forward indicators for signs of a turnaround.  Unemployment and other economic releases are history, they have already happened.  The market is less interested in the absolute numbers and more in the degree of surprises, up or down, when it comes to trailing or historical indicators.  The surprises lately have not rattled investors.

Further, anecdotal evidence suggests that the recovery among certain manufacturing industries is in sight.  The Credit Suisse First Boston Technology conference of last week was the sight of a number of positive announcements.  Applied Materials said that excess semiconductor inventories have moved from 4 months to 4 weeks.  Texas Instruments discussed backlogs stabilizing as did EMC, implying that pricing conditions are normalizing i.e. still falling but no steeper than previously seen.  Motorola said handset orders exceeded sales in the third quarter, which is notable in light of more conservative forecasts from Nokia.  Veritas was very excited about recent demand for data recovery and business continuity products.  The message was that information technology spending was by no means dead as was stated by many just months ago.  Michael Dell pointed out that 30% of desktops are more than three years old, representing an installed base of 150 million units.  Finally, John Chambers of Cicso stated Wednesday that business activity was meeting expectations.

This week’s markets acted extremely well.  The big runs of Tuesday and Wednesday were not followed by significant profit taking or dumping on negative economic or war news.  There has been some profit taking and I expect some tax-loss selling over the next few days, but the market’s strength is hard to dispute.  The mid-week rally had the feel of a buying flurry as short-sellers covered and money managers bought to avoid being left behind.  Market breadth has improved substantially as 75% of the S&P 500, MidCap 400 and SmallCap 600 constituents have posted advances, unlike the narrow breadth that characterized the January and April rallies.  Another technical note, the NYSE Cumulative Advance/Decline line has built a strong foundation, which is a requirement for a new bull market.  Volatility in the markets is declining making it safer and more inviting for more cautious bond investors who will begin moving away from the low yields in the bond and money markets and into the stock market.  Treasury yields have reversed their course in the last few days, indicating the bond markets expect greater economic strength ahead.

As I have said for the past several weeks, the future looks bright indeed for equity investors.  If you have been holding cash, waiting for an opportune time to get into the equities market, now is the time.