22 Oct 2010 Recovery Continues, Slowly
The economy continues to flounder with few signs of improvement in unemployment. Unemployment remains entirely too high with few prospects of decline any time soon. Housing remains in near depression as would-be buyers cannot sell their current homes or they worry about losing their jobs, or they cannot find financing. Manufacturing continues to grow, but much slower than earlier in the year, and not fast enough to create jobs. But there are at least two bright spots, (not counting the growing possibility of a gridlocked Congress forced to compromise). The consumer appears to be increasing his outlays for goods and services and the stock market continues to recover from 2008.
On Wednesday the Fed released its ‘beige book’ survey of economic conditions throughout the 12 Fed districts. The report showed that economic activity “continued to rise, albeit at a modest pace.” The report added evidence that a double-dip recession is not in the cards at this time.
The week’s housing reports delivered a decidedly mixed picture. Homebuilders reported the first increase in activity since the government stimulus ended this spring. The index rose 3 points with gains in expectations, current sales, and traffic. The improvement was evident in several regions across the country. The report noted that financing remains difficult for buyers and builders.
Housing starts rose .3% in September after jumping 1.5% in August. The annualized pace of 610,000 units bettered the market forecast for 580,000 units and is up 4.1% compared to a year ago.
Building permits went the other way, falling 5.6% following a 2.1% rise in August. Weakness was in the multifamily component which dropped 20.2% after a 9.8% rise the prior month. Single-family permits edged up 0.5% in the latest month after dipping 0.7% in August. Overall permits came in at an annualized rate of 539,000 units and are down 10.9 percent on a year-ago basis. Could this be an indication that demand in the rental market is peaking? Might it also indicate a bottoming of the decline in housing following the withdrawal of government stimulus?
Manufacturing, a catalyst in the early stages of recovery, continues to expand, but much more slowly. The government announced that industrial production declined .2% in September, following a .2% gain in August. Capacity utilization edged lower to 74.7% from 74.8% in August. Analysts expected a rise to 74.8% for the latest month. As the dollar weakens, however, manufacturing prospects for exported goods improve.
The government announced its index of leading economic indicators yesterday. Most of the .3% rise in September is explained by the continuing large contribution of the yield spread (10-yr Treasury minus Fed Funds) and money supply. But on the negative side, quickening delivery times, falling building permits, and weak consumer expectations depressed the outlook. But as we have pointed out, building permits and consumers are picking up a bit.
Stocks have continued to rise in the last few weeks with few exceptions. The drop of 1.5% on Tuesday was blamed largely on an unexpected rate increase in China. But since late August, the market is up just under 13%.
Adequately explaining the rally in the face of a sluggish recovery has been difficult. Generally speaking, corporate earnings explain market rises. They have been good and are expected to remain so for the foreseeable future. Earnings for S&P 500 companies are expected to increase 24.2% from a year ago, which is up from 23.6% a week ago and 23.8% on October 1st. Companies are beating estimates more often this year as well. According to Thomson Reuters, since 1994, about 62% of companies typically beat expectations over an entire reporting period, but that figure has averaged 77% over the past four quarters.
Another reason equities are doing so well is that dividends are rising dramatically. S&P reports that of the approximately 7,000 publicly owned companies that report dividend information to them, only 35 decreased their dividend payment during the third quarter of 2010. They also report that for the same period, the forward net change in the indicated dividend rate increased $5.1 billion, comparing favorably to the $3.0 billion registered in the third quarter of 2009. On a dollar-weighted basis, the first nine months of 2010 saw a net gain in annual dividend rates of $18.5 billion compared to a $45.7 billion decline in rates during the comparable period of 2009.
Individuals who depend on dividends have directly saved $274 billion through George Bush’s dividend tax cuts from 2003 through the sunset 2010 period. But the tax cuts are set to expire unless Congress acts. S&P points out that “the substantial increase in dividend taxes will leave investors with significantly less net income; however, even at the higher scheduled tax rate, dividend yields will remain competitive with other instruments. For investors who truly require higher returns, they are going to have to accept additional risk, which runs counter to the basic approach of dividend safety.”
If you are missing this rally because you got out after being badly burned in 2008, take heart, you are not alone. Some of the biggest and brightest are on the sidelines with you watching stocks rise. An article in Monday’s Wall Street Journal reveals that “after making the same kinds of investment blunders as many individuals, corporate pension funds now are seeking the same remedies: fleeing stocks for the perceived safety of bonds.” Corporate pension plans piled into stocks in the gogo 1990s and reached an equity allocation near 70% by the mid-2000s; a pattern similar to individuals’. By July of this year, pension plans had cut their stock exposure to 45%, according to the Center for Retirement Research at Boston College. Many say the trend will continue. A statement in the midst of the article could not better endorse our philosophy.
“A growing number of pension managers are concluding their pursuit of maximum returns was a mistake, interviews with managers and consultants show. Instead, many funds are trying to achieve stable returns that more or less keep pace with the plan’s obligations.”
Why on earth would anyone take greater risk than is required to accomplish every goal with confidence?
Have a great weekend.