Stock Values Compelling, If the Economy Holds

The economy’s growth is slowing across the board; jobs, consumer spending, retail sales, inflation, and manufacturing. Today’s jobs report shows that employers added 92,000 workers to payrolls in July, which was fewer than expected and fewer than June’s 126,000 gain. The slowdown reflects the first decline since January 2006. The jobless rate rose to 4.6% also for the first time since January 2006. Workers’ average hourly earnings rose 6 cents, or 0.3%, in line with forecasts, after a 0.4 % increase in each of the previous two months.

Service industries added the most jobs with 104,000 new workers, while manufacturers’ payrolls shrank by 2,000. The manufacturing work week held at 41.3 hours, and overtime remained at 4.2 hours.US construction spending unexpectedly took its first drop in five months during June as the housing slump continued. Jobs and wages are critical in keeping consumer spending from slowing more than it has.

Personal consumption grew only .1% in June following an increase of .6% in May.  June’s increase was the weakest showing since a .1% dip in September 2006. Spending rose at a 1.3% annual pace from April through June, a third of the previous quarter’s increase and the smallest gain in more than a year, according to the Commerce Department. 

Personal income rose at a seasonally adjusted rate of .4% compared to the month before which likely bolstered consumers’ outlooks. The Conference Board’s consumer confidence gauge rose to its highest level in six years in July. 

With consumer spending slowing, so is inflation, according to an important measure of prices. The price index for personal consumption expenditures (PCE) rose .1% in June compared to the prior month. It follows a .5% in May. Removing food and energy, the core PCE rose only .1% for the fourth straight month during June. This trend may convince the Fed that inflation is truly moderating. But as of last month Ben Bernanke stated in his testimony before Congress that a sustained decline in the inflation rate is “yet to be convincingly demonstrated.”  The Fed’s most recent regional survey, known as the Beige Book, showed last week that employment rose in most districts and that many locations also reported “significant upward pressure on wages and salaries for in-demand, high-skilled workers.”

The Institute for Supply Management’s manufacturing index, released Wednesday, fell to 53.8 from 56.0 in June.Readingsover 50 indicate rising activity at factories, but the trend is decidedly slowing. The numbers also showed that inventories were swelling, suggesting that demand was slowing.

But as the USeconomy continues to slow, strong demand from overseas might be able to pick up some of the slack. According to the Wall Street journal, “a research note from economic research firm Global Insight said today’s ISM survey ‘shows clearly that much of the momentum is coming from overseas, as the export orders index improved slightly while overall order growth slowed down.’ Goldman Sachs economists concurred saying ‘exports were one of the few components that increased, reflecting continued strong global demand.’ Earlier this week in their surprisingly upbeat quarterly reports, both Ford and GM told stories that also suggested strength in overseas markets. Ford reported that second-quarter operations outside North Americaearned $764 million before non-operating items, more than balancing out the $279 million loss from its North American business. Meanwhile, GM substantially slimmed its North American losses during the second quarter, but it was growth in Asia and Latin America and Europethat helped the company produce its $891 million profit.” Among 375 members of the S&P 500 that have reported second quarter results, profits have risen an average of 10.8%, according to Bloomberg. That’s more than twice the average of analysts’ forecasts on July 13th.

So, if the US economy is slowing, but not too fast, the nagging question remains as to whether the global economy can continue to expand despite slowing demand from theUS. The world’s central banks will play a key role in the outcome. Yesterday they announced no increase in rates, but today Trichet said that “strong vigilance” is needed to guard against price pressures, a phrase policy makers have used a month before each of the ECB’s eight rate increases since late 2005. Going too far will certainly bring the expansion to a halt.

We think that caution is clearly in order. We are not suggesting that trouble lies ahead, but that the potential is rising. An important seasonal risk is the approaching hurricane season. Gulf storms have the potential to disrupt a large portion of US supplies of both crude and gasoline. With crude oil setting new highs, we could finally see economic damage from higher energy prices; an effect that has so far been benign. And, if the world’s central banks go too far in their zeal to contain the ‘threat’ of inflation they could slow growth sufficiently to stall the global economy.

We continue to hold stable and conservative indices in our models with cash balances ranging between 13% and 25%. Following last week’s decline, the S&P 500 was valued at 15.4 times estimated profit, the lowest since January 1991 when compared with actual earnings, according to Bloomberg data. While we may be in for some uncertainty and increased volatility, reasonable valuations should support markets and mitigate the amplitude of the swings.