Even though it does appear that the worst of the global economic downturn is behind us, there is a feeling that the anticipated recovery will take longer than previously thought. There are a variety of fundamental factors that the bears and the “slow growth proponents” on the economy are citing. One of these is the nonfarm payroll report that was released on July 2nd.  The market was shocked by the news of a 467,000 decline, when a drop of only 365,000 had been expected. This number was especially disturbing to those searching for “green shoots” in the economy, especially since there had been a pattern of smaller declines in employment reductions for the previous four months. It didn’t matter that the unemployment rate was not as bad as anticipated at 9.5%, when 9.6% was guessed, or that manufacturing payrolls declined by only 136,000, when a 150,000 drop was anticipated. Traders focused on the bearish headline nonfarm payroll number. The bears on the economy continue to cite the rising unemployment rate, which according to some analysts, could rise to over 10% later this year.


 
Countering the negative implications of the rising unemployment rate is the most recent jobless claims report for the week ended July 4th. This report showed a surprising 52,000 drop to 565,000, which compared to the average guess of 603,000.   Looking at the chart below, we can see a clearly defined trend toward smaller jobless claims numbers.

 

Another area of concern is the rising long term interest rates that some analysts fear could derail the limited “green shoots” of recovery in the real estate market.  There is a counter argument for this, as well. The “good news” for the real estate market is that the rate of decline in home values in many areas is declining.   In fact, there were some reports within the housing industry that actually were stronger than the analysts’ estimates. For example, May pending home sales, which are reported by the National Association of Realtors, were up .1%, when unchanged was expected.  On the surface a tiny increase in this index does not appear to be very noteworthy. What is most impressive about the report is that this skimpy increase marks the fourth consecutive monthly advance. Equally impressive is the fact that this is the first time that the index was able to register four straight months of increases in almost five years.  In spite of this, in some circles, the feeling remains that higher long term interest rates will forestall any recover in the housing market.

Another potential impediment to economic recovery lies in the concern that the Federal Open Market Committee could increase their fed funds target by 25 basis points to 50 basis points on or before their December 15th meeting. Although the probabilities of an interest rate increase from the Fed are diminishing, there currently is a 37% chance of tighter credit from the Fed, according to financial futures pricing. Our own analysis suggests that a rate increase from the nation’s Central Bank this year is very unlikely. However, there could be one later next year, especially if we are correct in our thinking that we are on the road to economic recovery. The vast majority of the primary government securities dealers also believe that there will not be an interest rate increase from the FOMC this year and that the financial futures markets are incorrectly pricing in such a high probability of a tighter Fed policy.  

In spite of the economic downturn, rising unemployment rates and talk of tighter credit from the nation’s Central Bank later this year, or in 2010, there are more and more signs that an economic recovery is around the corner. Another “green shoot” is the smaller than expected decline in consumer credit. In May, total U.S. consumer credit fell by an unexpectedly small $3.23 billion, according to the Federal Reserve. The median guess for this report called for a decline of $8.8 billion. This favorably compares to the revised figure for April, which showed a $16.52 billion contraction.

In addition, second quarter corporate earnings are likely to be better than the analysts’ estimates.  Keep in mind that last month’s corporate earnings reports were, on balance, better than anticipated because cost cutting measures were able to more than offset declining revenues. This situation remains today, which is a huge reason why we can expect the current earnings season to show results that are better than the analysts’ median guesses.  A perfect example of this is the earnings report from Alcoa Inc. After the close on Wednesday, Alcoa Inc. kicked off the second quarter earnings season by reporting a substantially smaller than expected loss.  The company’s loss, which excludes certain items, was 26 cents a share, which compares to the Street’s guess of a 38 cent a share loss. According to the company, much of the improvement was due to production cuts and workforce reductions. Alcoa is traditionally the first of the Dow Jones companies to report earnings and the rule of thumb is their earnings and guidance are often the bellwether for the rest of the Dow Jones companies’ earnings results.
                                          

S&P 500 Futures – Weekly Continuation

Many traders and analysts are worried that higher short term interest rates and firming commodity prices are bearish for the economy. We take an opposite view. At this stage of the economic cycle, a higher interest rate structure is a reflection of anticipated greater loan demand in the near future and firming commodity prices suggest manufacturing activity is about to increase. If we are correct in our thinking that the economy is recovering, we can expect loan demand to increase. Our analysis continues to show that the worst of the global economic downturn is behind us and that we can expect the majority of the economic reports for the balance of this year and though 2010 to be stronger that the analysts’ estimates. All of this is bullish for stock index futures prices. Most likely the lows for the move have been made and a new multiyear bull market is emerging.  

If you would like more information about this article, please contact Alan at 1.800.243.2649 or email him at alan.bush@archerfinancials.com .

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