Current Economic Conditions
Even though it does appear that the worst of the global economic downturn is behind us, there is a continuing 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. While much of the economic data in August and September was, on balance, stronger than the analyst’s estimates, some of the very recent reports have disappointed. For example, the October consumer confidence index was a weak 47.7, when 53.5 was anticipated and the September new home sales report showed a 3.6% decline to 402,000, which compares to an estimate of 440,000. This housing report was a surprise and the first drop since March. The bears on the market have ramped up their rhetoric now that they finally got their long awaited correction. As a result, we are seeing more intense bearish comments from the analysts that are negative on the economy and on the equity markets. One analyst said stocks will “drop painfully from current levels.” One well known fund manager went so far as to say that U.S. stock markets had topped out, while other analysts were not quite as pessimistic when they said company valuations were far ahead of where the fundamentals are. One common theme among the bears is their predictions of the possibility of a double dip recession. My work suggests that there will not be a double dip recession. However, I must admit that I have been and remain in the “slow growth” camp for the near term, but I believe that it is very likely that the rate of growth in the recovery will accelerate next year and beyond.
The bears were not impressed by news that corporate earnings have been much better than expected in the past three quarters. In fact, one study showed that 83% of the companies in the S&P 500, that have reported third quarter earnings, have been better than the analysts’ estimates. The bears maintain that the strong earnings numbers were only due to cost cutting measures and that revenue was generally less than expected. That was largely true in the first and second quarter results, but this situation has been less prevalent for the third quarter. For example, Intel Corporation reported that revenues were more than estimated by about $1 billion, along with earnings that were much better than analysts’ expectations.
Many traders and analysts are worried that higher short term interest rates and firming commodity prices are bearish for the economy. Firming commodity prices in the past were thought to be a bearish influence for the economy because of their inflationary implications. We take an opposite view. Under the present circumstances, rising prices for commodities are being viewed as a sign that manufacturing activity is about to increase. At this stage of the economic cycle, a higher interest rate structure is actually a bullish development since it can be construed as an indication of anticipated greater loan demand in the near future. If we are correct in our thinking that the economy is recovering, we should not be afraid of rising interest rates. 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’ expectations. Our analysis, which places considerable weight on the shape of the yield curve, which is upward sloping and is considered to be normal, continues to suggest that there will be a slow recovery that will gradually accelerate into next year.
Interest Rate Outlook
A perceived impediment to economic recovery lies in the concern that the Federal Open Market Committee could start to take away some of the accommodation. There is the fear that rising interest rates, according to some analysts, could derail the fragile recovery. Our own analysis suggests that an interest rate increase from the nation’s central bank this year is very unlikely. However, there most likely will be tighter credit from the Federal Reserve later next year, especially if we are correct in our thinking that we are on the road to economic recovery. The Fed Funds contract is currently factoring in a 68% chance that the Federal Open Market Committee will increase their fed funds target by 25 basis points to 50 basis points at the their April 28th meeting. A recent survey of economists was a little less hawkish, suggesting that the Federal Reserve will increase the Fed Funds target rate at or after the August 10th meeting.
When analyzing Federal Reserve policy there is one thing that is paramount. The Fed is almost always late. Policy changes almost always follow the price movements in the free markets. Therefore, if we are correct in our thinking that the economy is in a recovery mode, even though the recovery is slow, we can anticipate higher interest rates now, which are likely to take place well in advance of when the Fed increases interest rates next year. For the balance of this year and well into next year we are anticipating that prices for the Treasury futures market will trend lower.
Stock Index Futures Outlook
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 and corporate earnings reports, for the balance of this year and well into next year, to be stronger than the consensus view. This, of course, will continue to support this new bull market in stock index futures, in spite of the correction that we are currently seeing. I would not rule out the possibility of new highs for the indexes later this year.
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If you would like more information about this article, please contact Alan at 1.800.243.2649 or send him an email to alan.bush@archerfinancials.com.
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