Last week’s breakout was confirmed. After a pause earlier in the week, the stock markets reached the highest levels of the year and then pulled back a bit. The combination of continued positive earning’s reports and a chance statement by President Obama conspired to move the markets higher for a third consecutive weekly gain. As a result both the S&P 500 and the Dow have turned positive for the year while the NASDAQ continues to outperform.
President Obama was widely quoted as stating that the recession is over earlier in the week. Actually, it was not the president but Newsweek Magazine that claimed “The Recession is Over” in their most recent cover story. He was simply commenting on the story but the media choose to ignore that. In any case, the continued good news on earnings and some positive housing numbers built the case for further upside gains.
Friday, the government announced preliminary second quarter GDP data. Economists were looking for a decline of 1.5% following the first quarter’s dismal 5.8% fall. The numbers came in at -1% (better than expected) however the fall in the revised first quarter numbers was even worse at -6.4%. That gave investors reason to pause since this data is giving off mixed signals.
“Consumption is the largest chunk of Gross Domestic Product,” explained Polina Vlasenko, Research Fellow and Economist at Great Barrington-based, American Institute for Economic Research. “And that number declined 1.2% last quarter after rising in the first quarter by .06%.”
Given that the United States is the land of consumers, conventional wisdom states that there can be no recovery here without an increase in consumption. So how come the GDP number came in stronger than most economists expected?
“This was simply an advanced estimate, a best guess, and will be revised again multiple times,” says Vlasenko, “we could end up with -2%, 0% or even a positive number over time.”
The problem, she explained is that a lot of the data the government needs for a definitive GDP number takes time to gather. So in the meantime they use estimates, statistical guesses that may miss by a large margin especially when an economy is in transition and the business cycle changes from growth to recession or from recession to recovery like we are experiencing now.
“The best we can say is that the economy is not falling off the cliff as fast,” volunteers Vlasenko, “but can we really call another negative number an improvement?”
Granted the economy is still declining but as I’ve written before investors are focusing on the rate of change and there they do see a vast improvement from the 6.4% decline just three months ago.
One bright spot in the numbers was government spending, which accounts for 18% of GDP that improved by a whopping 10% versus last quarter’s -4.3%. Most of that increase came as a result of the huge Obama stimulus package which is finally trickling down into the local economy. It appears that the president was right when he said that without the stimulus, the economy (and unemployment) would be far worse than it is. The bears however pounced on the GDP number to bolster their case that the markets have overstayed their welcome on the upside. I disagree.
As I wrote last week, a staircase pattern of gains followed by a pause, some back and fill, and then another move higher is developing in the markets. Granted the move up has been accompanied by anemic volume but the entire move from the March lows has been accomplished on low volume. As long as the S&P can maintain this pattern (two steps forward, one step back) the markets should climb higher. As it does, confidence among investors and the consumer at large will begin to re-build. Remember, the stock market is one of the leading indicators of the economy that we all watch.
Now that the earnings season is winding down, investors will re-focus on economic numbers, especially unemployment and housing for hints of a recovery. Lately, energy prices have also become somewhat of a barometer of economic growth. A growing world economy consumes more oil (price rises) while one in recession consumes less (prices down).
Health care reform will also be watched closely both for its impact on the sector (which has done well in this rally) as well as for its impact on the overall economy.
Another confidence builder could be merger and acquisition activity. An increasing number of deals have been announced in the biotech, pharmaceutical and technology sectors. The real test, however, on whether the markets have developed sufficient depth and strength to move higher will be the resurgence of the IPO (initial public offering) markets. That appears to be awakening as well.
Finally, remember that the markets will remain volatile. At the moment, stocks are overbought and extended to the upside so short, sharp corrections can and will happen when you least expect it. It’s all part of the game and so far the bulls are winning. I’ll start to pull in my horns when I sense confidence is becoming the majority view. I estimate that won’t happen before another month or two of data is accumulated. Until then have fun.