Strong Signs the Worst Is Over, But Recovery Remains Elusive

On Tuesday of this week the government announced that U.S. retail sales rose more in October than in any month in the government’s 10 years of record-keeping.  Consumers spent money at auto dealers, department and discount stores, and building supply outlets.  Sales surged 7.1%, almost three times analysts’ expectations, after falling 2.2% in September. The Commerce Department’s report also showed sales excluding a record increase in purchases from car dealers rose 1% after falling 1.5% in September. The rise in vehicle sales was a result of no-interest financing offered by automakers.  General Motors has announced a continuation of their 0% program through January 15th

We have discussed how important the consumer is in maintaining stability, as consumer spending represents two thirds of our economy.  People are becoming more optimistic about their finances and the economy, stock prices have increased since their September lows, while cheaper gasoline and home refinancing are freeing up some extra money.  The average weekly price on a gallon of retail gasoline fell as low as $1.28 in October from $1.52 at the end of September, according to Department of Energy figures.

Leading the way were cars, trucks and parts, which rose a record 26.4% last month after falling 4.5% in September.  Automobile sales jumped to a record 21.3 million units at an annual rate in October, exceeding the 21.2 million pace set in September 1986, industry figures showed.  Sales at department and discount stores increased 0.7% after falling 0.5% in September. Sales at clothing and accessory stores rose 6.9% last month after a 5.9% decrease in September.

A separate report on Tuesday from the Mortgage Bankers Association of America showed applications to refinance home mortgages rose to a record last week.  Refinanced mortgages provide homeowners a boost in their discretionary income as their payments decline.  Often, they free up additional equity from their home as well, further improving their spending power.

The specter of unemployment showed signs of weakening as jobless claims unexpectedly declined last week. The number of workers filing first-time applications for unemployment benefits fell by 8,000 to a two-month low of 444,000 in the week ended Saturday, the Labor Department said.  The four-week moving average of claims fell 13,000 to 474,750.  But the total number of people drawing unemployment benefits rose 126,000 to 3,826,000 for the week ended Nov. 3, the highest level since Feb. 12, 1983.  Economists had expected initial claims to jump by 25,000, according to a survey by Thomson Global Markets.  Many economists expect the labor market to weaken until next summer, when the unemployment rate is expected to rise as high as 6%. The unemployment rate was 5.4% in October.  Remember though, the growth of unemployment doesn’t reverse until the economy is already in recovery.  In fact the market always gets it before employers do.  The chart below shows that stocks actually go an average of 24% in the year following unemployment rises of at least 40%.

During the present economic cycle, the unemployment rate has risen by nearly 40% from a level of 3.9% in October 2000 to 5.4% currently.

Inflation is not a problem at all as U.S. consumer prices, announced today, dropped in October for the second decline in four months.  The last time the consumer price index fell twice within a four-month period was February through April 1986.  Aside from this year, the CPI has dropped only one other time in the past 15 years.

With the bank overnight lending interest rate at the 40-year low of 2%, businesses will be in “a far better position to move forward,” Fed Chairman Alan Greenspan said after a speech in Houston this week. The “fairly dramatic decline the Federal Open Market Committee has initiated since the beginning of the year has very clearly had marked impact within the financial structure.”

The congress will not pass a fiscal stimulus bill before the Thanksgiving break, but they promise to enact some form of stimulus measures upon their return.  There is, however, a growing belief among economists and lawmakers that the effects of any fiscal stimulus at this point will likely be ineffective for months to come.  As this belief grows, the size of the stimulus package likely diminishes.  Further, the Democrats and Republicans are so far apart on the issue; the likelihood of enactment of an effective package is low.  Any package passed should be concentrated on business investment, where our economy is clearly weakest.  In several significant areas of the economy, the declines in consumer spending appear to be reversing.  Historically low interest rates will eventually have the desired effect of stimulating consumer spending.

If you have been sitting on some cash, waiting for an opportune time to get into the market, the conditions are rarely better.  Remember, bull markets climb a ‘wall of worry.’  The negative talk from analysts and prognosticators is actually very healthy as it keeps the market’s recovery from getting ahead of itself.  The problem for many analysts is that they base their stock valuations on currently depressed earnings and on future earnings projections that are excessively pessimistic.  Just as their projections were wildly optimistic during the bubble, today’s negative environment has forced analysts’ projections to the opposite extremes.