COMMENTARY: MARKET TAKES ON AN UNINSPIRED MIEN
Despite earnings reports from some big names this past week, including
companies like DUPONT (DD, $44, unch.) and MCDONALD'S (MCD, $23, up 2),
investors didn't seem much interested. Volume throughout the week was
low, and all the major indices closed just slightly down nearly every day.
THE DOW JONES fell 131 points, or 1.4%, to close at 9154.
THE S&P 500 dropped 19, or 1.9%, to finish at 980.
AND THE NASDAQ slipped 15 points, or 0.9%, to end the week at 1716.
Many investors no doubt find this kind of action confounding, given that
the bulk of America's major companies have reported earnings and the best
part of them have topped Wall Street expectations. In fact, so far 66% of
the reporting companies in the S&P 500 have beaten analysts' estimates,
compared to 22% that matched expectations and 12% that fell short.
So what gives?
Well, for one thing these kinds of returns were priced into the market a
long time ago. Barring a boatload of bad news or an abundance of awesome
profit growth, share prices were not likely to move much this earnings
season -- a point we noted prior to the onslaught of 2Q reports.
Investors have banked so much on the third quarter and on the second-half
recovery that they have looked past the 2Q results.
That is not to say, however, that investors have been impervious to news
during the past five days. It is difficult to dismiss the influence a
number of developments must have had on investors, convincing them to at
least stop and think about what's happening in the American economy.
On the job front, there has been little improvement. The unemployment
rate dropped from a nine-year high in June to 6.2% in July, but much of
that decline came thanks to 500,000 Americans simply giving up any hope of
finding a job. If you're not looking, then you're not counted, according
to the US Government. Furthermore, weekly hours worked dropped to a
record low of 33.6 hours. Take these two together and you have a scenario
that forces consumers to either spend less or accumulate more debt trying
to maintain their current standard of living.
The drop in the volume of mortgage refinancing is about to produce the
same consequences, though we would say on a much more profound level than,
for instance, working fewer hours a week. For months refinancing has
enabled homeowners to take money out of their homes and spend it. That
has been the Fed's formula for recovery. But with huge budget deficits
pushing long-term interest rates higher, the refinancing engine is
slowing. This will cause billions of dollars NOT to be put into the
economy and will put a drag on demand and prices.
That's ironic, in a painful way, because the Federal Reserve lamented in
its Beige Book report last week that weak demand remains a thorn in the
economy's side. Deflation, not surprisingly, continues to weigh heavily
on the mind of Fed Chairman Alan Greenspan.
Consumer, corporate, and government debt levels, plus the lack of demand
and the lack of pricing power, would not be as disconcerting, perhaps, if
over the past several quarters the core problems in the economy were
solved. For instance, if profits were coming back strongly and companies
were hiring based on solid evidence of a recovery, then rising long-term
rates, for example, might not look so threatening. But that has not been
the case. Instead, we have the CEO of one of America's largest
conglomerates, GENERAL ELECTRIC (GE, $28, unch.), telling us that excess
capacity -- one of the things that got corporate America into this
earnings mess -- will continue to hinder growth in the U.S. At least one
major problem, in other words, has yet to be resolved.
Will the painful process of working out that excess capacity begin this
quarter or not? That remains to be seen. But investors, still optimistic
enough for now to hold onto their shares and buy more, will be walking the
high wire over the coming weeks trying to guess the answer to that very
question.
ECONOMY WATCH
1. US POSTS SURPRISING ECONOMIC GROWTH
The Commerce Department released its initial estimates of 2Q Gross
Domestic Product growth on Thursday, reporting a surprising jump to a 2.4%
annualized rate. In contrast, final 1Q estimates clocked in at a 1.4%
pace; economists had expected GDP growth to tick up to just 1.5%. The key
to last quarter's brisk expansion pace was defense spending, which notched
its largest increase since the Korean War. Excluding the numbers from the
Defense sectors, GDP grew at a 0.7% rate. Business spending jumped a
brisk 7% after a 4% decline in the first quarter, and consumer spending
rose 3% to its highest rate since 3Q02.
This is a strong sign that forecasts for a second-half economic recovery
are correct. We could see growth of 4.6% this quarter; if that happens,
then this rally could finally signal the end of the bear market. Hey,
after economists got it wrong in 2001 and 2002, maybe the third time's a
charm, after all!
2. MIDWEST MANUFACTURING PICKS UP
In another positive sign for the economy on Thursday, the Chicago
Purchasing Managers Index of manufacturing activity remained above 50 for
the third straight month, rising from 52.5 to 55.9 in July, above
expectations of a 53.7 reading. Readings above 50 suggest production
expansion in the region. The improvement in the Index suggests that the
worst is over for the struggling Manufacturing sector, and another sign of
a forthcoming second-half recovery.
3. JOBLESS CLAIMS FALL BELOW 400,000
The Labor Department reported on Thursday that Jobless Claims fell to
388,000 in the latest week, their lowest level since February. Last
week's number of 386,000 was revised to 391,000 claims. This is the
second straight month that Claims have been under 400,000. The four-week
average, while remaining above 400,000, fell by nearly 12,000 claims to
409,000. Will this streak of sub-400,000 readings turn into a lasting
trend, or will it be another temporary decline? Considering Thursday's
other data, we're leaning towards an improving job market.
4. JOBLESS RATE DROPS, BUT SO DO PAYROLLS
The nation's Jobless Rate fell from a nine-year high of 6.4%, to 6.2% in
July, according to the Labor Department on Friday. However, US companies
continued to slash payrolls, cutting 44,000 jobs after shedding 72,000 in
June. That's the sixth straight month of job losses, boosting the total
over the period to almost 500,000 jobs. Economists actually expected
companies to add 13,000 jobs during the month. So why did the Jobless
Rate fall, even though more workers were fired? Because a horde of job
seekers stopped looking. In fact, more than 550,000 Americans gave up on
their job searches last month -- the most since May 1995. This report
deals a serious blow to the recovery in the job market, and it wipes away
the luster of improving Jobless Claims figures.
5. ISM INDEX SHOWS EXPANSION IN MANUFACTURING
The Institute for Supply Management released its latest Manufacturing
Index on Friday, recording an increase from 49.8 in June to 51.8 in July
-- suggesting an expansion in the sector. That's the first time that the
Index has topped 50 since February, and its highest level since a 53.9
reading in January. New orders were particularly strong, rising from 52.2
to 56.6 last month. That's an important number, since it suggests that
companies are gearing up for a second-half business pickup.
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