The Fading Summer

Nor…wilt thou then forget, that on the banks of this delightful stream we stood together.” – William Wordsworth, Lines composed above Tintern Abbey

by M. Kevin Flynn, CFA

One of the most difficult fences to hop coming out of every recession is the media coverage. Equity markets aren’t the only players in the economy that are susceptible to momentum runs. The business and mainstream press gets caught in a rut as well. Add in the fact that grim headlines tend to be more of the stock in trade, and you can see why the press tends to remain deeply skeptical long after a recovery has started.

Journalists have some good reasons for their skepticism, too. The excesses that lead to recessions are always orphans whose parentage is suspected everywhere and admitted nowhere, or at least not publicly. The last two recessions came along with crashes that were painful and destructive, and naturally the average person would like to know whose fault it was (surely not our own).

No one ever comes forward, except to volunteer that the problem lay in some ruinous political approach that it seems that the author had long warned us about. What’s more (the author will solemnly continue), the world as we know it is about to come crashing down about us – unless we buy his or her book and immediately adopt its severe political philosophy (why they are always severe, we’re not sure. Probably a bit of hair-shirt and self-flagellation just sells better at such times).

Since there is never much agreement about what led to the dolorous times, it’s to be expected that there will be controversy about what needs to be corrected. Reporters are hardly omniscient in these matters. They may be quite intelligent and aspire to the highest levels of objectivity, but they are constantly under siege by factions peddling their own self-interest. Few have any practical experience. For that matter, even the expert driver may understand very little of an engine.

There are three main actors on the economic stage, government, business, and the individual consumer. In general, one may safely say that all are willing to take the credit for the good times, and to assign the blame elsewhere for the bad. This particular column happens to believe that the economy is the result of the efforts of all three, but how much fun is that?

Take education, for example. If a child has trouble in school, the parents blame the teacher, the teacher blames the parents, and all of them blame the government. With the economy suffering, the right blames the left, the left blames the right, and all of them blame the government – the previous one if you are on the left, the current one if you are on the right.

Although most on either side might agree that the economy simply can’t be fixed quickly, the current malaise does afford a useful opportunity. The right gets to say that the lack of recovery is the fault of the left, the left gets to say that the depth of the hole is the fault of the right (both sides eying the elections), and the press gets to act terrifically grim (never hard for journalists, the recent years of brutal bloodletting in the media business haven’t exactly improved their humour).

In the midst of the din, though, the economy is improving. Most of the noise, as is usually the case in these situations, is about the speed, righteousness, and source of the improvement. Things went well in the spring, and we got too giddy. Since that time, things have slowed down, equities have struggled, and so the local paper (the Boston Globe) runs “2nd Slowdown is Feared” as its Sunday headline.

Things went the same way in each of the previous three recessions. Only the 1980-1982 version produced an actual double-dip, but it just wouldn’t be a real recession without fears of the double-d.

But what you really want to know is, where are the markets going? Well, consider that last year, the economy wasn’t anything great. Unemployment rose, along with the deficit. So how did the stock market roar? After weeks of pricing in the end of the world, the realization that it wasn’t quite yet disintegrating sent us on a long rally that began while GDP was still contracting.
For nearly two months, the bond market has been pricing in the end of the world. Four weeks of sliding equity prices have left them at levels that are anything but expensive. Now, keeping in mind that crashes come from a height, ask yourself: which is at higher levels, the stock market or the bond market?

The markets are setting up to catch everybody wrong-footed once again. Most people we meet these days tell us that the equity markets are about to crash. Beware the crowd – it is almost never right.

The Economic Beat

We are going to start by telling you the one piece of data that really mattered last week. You won’t have read it elsewhere. It was buried deep within the weekly claims data, which were announced to have fallen more than expected to the level of 473,000.

That seemingly good bit of news was quickly lost, however, on observers fixated on the fact that claims from the prior week were revised higher, to 504,000. The shocking “five-handle” phrase seemed to be on everybody’s lips all week long, especially those who gain further attention by grimly assuring us that we are headed for the double-dip.

If you’ve been reading this column the last few weeks, then you know that we think the Labor Department has its seasonal adjustments wrong. Actual claims weren’t 504,000 the week before last, they were 404,000, or 100,000 less. We think that the combination of overweighting last year’s data and this year’s bulge of temporary census workers filing claims has distorted the seasonal weighting. The so-called “five-handle” never actually happened, and the adjustment may be a statistical mirage.

Whatever you want to think, though, we can tell you a concrete fact entirely overlooked in all the wailing. Last week’s actual number of claims tallied 380,935. Unless that number is revised very dramatically higher, it is the lowest number of real weekly unemployment claims since Lehman Brothers filed for bankruptcy.

That’s right, folks. The number of real claims hasn’t fallen below 390,000 since the week of September 13, 2008, three days before the Lehman bankruptcy. It was 381,270 that week, so last week’s count, still slightly below, might yet be revised above it. It will almost certainly stay below 390,000, though, making it the lowest level in nearly two years. We didn’t see that reported anywhere. It looks to us like the labor markets are better than what you’re reading. Not great, perhaps, but definitely better.

That might not carry over into next Friday’s jobs report, because the same department makes seasonal adjustments to that report too. The manufacturing expansion has clearly sat down for a breather, and there is no seasonal hiring boost from construction this year. August hiring may have been tepid, and the census layoffs will hurt the total number. But claims are improving, and that’s a start.

The two other big reports last week were durable goods and the first revision to second quarter GDP. We’re always a little skeptical about the value of the latter, coming months after the quarter was over, but the coulda-been-worse result of 1.6% cheered markets (some had dropped their forecast to around 1.0%).

It was another number to look below the headlines. Much of the downward revision came from a big surge in imports, which is hardly a sign of weak domestic demand. In fact, final domestic demand was actually revised higher. As the Financial Times reported, the 32.4% increase in imports, the largest in 26 years, was artificially boosted by a change in Chinese export duties that is likely to reverse in the third quarter (imports are subtracted from gross GDP).

The really poor result last week was the data on July durable goods, which reported a drop of 3.8% excluding transportation and a startling drop of (–8.0)% for the business investment category (non-defense capital goods excluding aircraft). Although the overall total rose by 0.3%, that was thanks to Boeing’s (BA) order book, and the stock market sold off accordingly. That result echoed the negative result for the latest Philadelphia Fed business survey and the weaker-than-expected New York survey.

However, it’s worth noting that some of the weakness was due to June being revised higher, and the June-July drop in capital goods new orders is not uncommon. The stair-step recovery is still operative.

Existing home sales hit a new post-war low in their annual rate, but readers of this column weren’t surprised. We’ve been saying all along that home sales were going nowhere this year, particularly after the tax credit expiration. Mortgage-purchase applications in August haven’t shown any improvement, either. The markets seemed to have finally gotten the message that it’s a lost year for housing, but at least next year’s comparisons will be easy.

Aside from the jobs report on Friday, next week will carry the third quarter’s first reports on personal income and growth (Monday), construction (Wednesday), pending home sales and factory orders (both Thursday).

August will be well represented too, featuring the latest survey results from the Chicago PMI (Tuesday), ISM manufacturing (Wednesday) and services (Friday). The Fed minutes come out on Tuesday as well. It’s a very busy week, but expect the jobs report to remain the focus of attention.