A Time for Caution
Fidelity Viewpoints
By Bill Ralls, CFA, Senior Vice President, Investment Services, Research
February 05, 2010
After a rousing first few weeks of the year for the U.S. and global stock markets, the bulls retreated and many investors are questioning whether the global economic recovery is weakening. The S&P 500® Index lost 3.6% and MSCI EAFE fell 4.4% in January—the worst monthly returns for both indices since the market collapse in February of last year. The fiscal and sovereign debt woes of Greece, Portugal, Spain, Ireland, and Italy have rattled markets and raised doubts about the strength of the recovery in the European Union. Back on this side of the Atlantic Ocean, the choppy path of the U.S. equity markets has mirrored some questions and concerns raised by recent domestic economic data reports. Stubbornly high U.S. unemployment and the recent bump in inflation has resuscitated a long-discarded economic yardstick last popular when disco dancing was all the rage.1 The so-called misery index, which is the sum of the unemployment rate and changes in the Consumer Price Index (CPI), is at its highest level since 1983. Despite strong fourth-quarter growth, caution is warranted.
The big plus: strong fourth quarter growth
On the positive side, the Commerce Department reported that U.S gross domestic product (GDP) expanded at 5.7% in the fourth quarter, the fastest pace of economic expansion in six years—easily exceeding the consensus expectation of 4.5%. In addition, the Institute for Supply Management (ISM) index rose to 58.4% in January from 54.9% in December, hitting its highest reading since August 2004. Echoing the strong GDP and ISM reports, the Conference Board, a business research group, had earlier reported an increase in its Index of Leading Economic Indicators (LEI) for December. Nine of the ten indicators in the LEI index registered a gain versus November.
The big minus: weak employment
There were other signs, however, that many areas of the economy remained sluggish. The Bureau of Labor Statistics (BLS) reported the unemployment rate was unchanged in December, remaining at 10%. This belied the disturbing news that the unemployment rate actually increased in 43 states (86% of all states). Three states had no change and only four states registered a lower unemployment rate in December.
In an encouraging sign, the Household Survey conducted by the BLS indicated that the jobless rate fell to 9.7% in January. However, the BLS also reported that job losses were more than 600,000 higher in 2009 than previously reported. While unemployment is typically a lagging economic indicator and a volatile data series often subject to revisions, the December and January reports are still reminders that many households remain under financial pressure.
Behind the growth spurt: slower destocking of inventories
Real (inflation-adjusted
After inventories, the largest contributor to fourth quarter GDP was consumer spending, which rose 2.0% in the quarter and contributed 1.4 percentage points to real GDP. Surprisingly, the overall government sector did not contribute to growth as combined federal, state and local spending fell $1.1 billion compared with the third quarter. An increase in nondefense federal government spending was offset by a decline in national defense spending.
While the headline GDP increase was welcome news, keep in mind that this is a first estimate issued by the Bureau of Economic Analysis (BEA) and is subject to future changes. For example, the first release of real GDP growth for the third quarter of last year was 3.5%. After two subsequent revisions, the BEA reported that the actual change in third quarter GDP was only 2.2%.
Will the economic growth continue?
The Conference Board reported that its Leading Economic IndexTM (LEI) increased 1.1% in December, the ninth month in a row with gains. The index is meant to forecast the direction of the economy over the next six to nine months. In addition to the monthly increase, the year-over-year and trailing three-month increases continue to point to an economy in the beginning stages of recovery. December was the ninth consecutive month with trailing three-month gains and the sixth month in a row with year-over-year increases.
The steep yield curve (the difference between short-term and long-term interest rates) continued to be one of the biggest contributors to the index's rise. The difference between the interest rate for 10-year U.S. Treasury bonds and the federal funds rate (the interest rate banks charge each other for loans) was 3.5 percentage points at the end of December, the highest level since June 2004. A steep yield curve is generally positive for banks because it allows them to borrow at low interest rates and lend money at higher rates.
A drop in the weekly average of initial unemployment claims was also a contributor to the LEI's increase in December. Average claims for December were the lowest since August 2008. However, since falling to 432,000 for the week ending December 26, 2009, initial unemployment claims rose in four of the next five weeks, resulting in an uptick in the four-week moving average—the first increase in the four-week moving average since last August. A return of net job growth is a critical component of a strong and self-sustaining economic snapback.
If the economy is doing better, why all the misery?
I recently attended a 1970s, disco-themed party for my younger sister's 40th birthday—so maybe I'm still trapped in the vortex of grooving tunes from the likes of Donna Summer and K.C. and The Sunshine Band. The darker side of that era, of course, was leisure suits and stagflation. While leisure suits do not appear to be coming back in style anytime soon, stagflation, the menacing combination of slow economic growth and rising inflation, is a remote risk. Also in vogue during the late 1970s was the misery index, a long-forgotten measure of the pain inflicted on consumers from the twin problems of rising inflation and unemployment.
Now fast forward to 2010. While the economic recession may have ended many months ago, the lingering impact on unemployment remains. After 22 straight months of job losses from January 2008 to October 2009, we got a respite from the carnage in November when the Bureau of Labor Statistics recently revised its November payroll report to show a gain of 64,000 jobs. The relief, however, was short-lived as job losses returned with a decline of 150,000 in December and a drop of 20,000 in January.
At this point, it may seem like the recently reported employment statistics are also trapped in the vortex of spinning disco lights. How could the unemployment rate fall to 9.7% in January while job losses rose by 20,000? The data comes from two different surveys. Job losses in nonfarm payrolls come from a survey of business establishments. The unemployment rate is measured by a survey of households. Many economists think the Household Survey may do a better job of capturing job trends at small companies and among the self-employed. The conflicting reports, combined with the recent increase in initial claims for unemployment insurance, make it difficult to gauge the health of the labor market.
The burgeoning economic rebound in the fourth quarter also brought with it a potentially less-desirable effect—inflation. For the eight months from March to October of last year, headline inflation had year-over-year declines (as measured by CPI-U reported by the Bureau of Labor Statistics). This was the longest such streak since 1955. In November, year-over-year inflation returned to the positive column. Led by a 19% year-over-year increase in energy costs, prices in December rose a seasonally adjusted 2.8% versus one year before. While this is still well below the long-term, year-over-year inflation average of 3.8%, the result is that the misery index stood at 12.8% in December, the highest level since May 1983.
The year ahead
In January, sequentially less negative economic data reports no longer seemed to give the market a boost as they had during the second half of 2009. Even clearly good economic news—such as the 5.7% rise in GDP—was more closely scrutinized by many commentators and did not translate into the same strong market lift as during last year's run-up from the March lows.
While the economic recovery looks on track at this point, the recent uptick in inflation, high unemployment, and conflicting signs in the U.S. labor market are concerns. Europe's sovereign debt woes are yet another potential blow to investors' confidence. A lesson I learned while attending my sister's disco-themed party comes to mind. However good I think I looked in my 1970s disco-dancing garb, not everyone I encountered on the street concurred. Likewise, even though the U.S. economy continues to look better with each passing month, a degree of caution is warranted. As the market pullback in January reminded investors, don't get carried away thinking the economy looks better than the data indicates. Sometimes the best feedback comes from walking down the street—or from the collective action of stock market investors.
(Bill Ralls is a senior vice president of research in the Personal and Workplace Investing [PWI] division of Fidelity.)
-- Plan Your Work and Work Your Plan to Get Ahead in 2009-2012..... KKP Investor ------------ ------------ Bull Markets are Born on Pessimism, Bull Markets Grow on Skepticism, They Mature on Optimism, and Die on Euphoria - Sir John Templeton ------------ --------- --------- ------ Bear Markets are Born on Recessionism, Snowball on Momentum & Technical-Breakdown s, Mature on Eco-Political- Nightmare Talks, and Die on World-Is-Coming- To-An-End Euphoria - KKP ------------ --------- --------- --------- -------- >BUFFET: My rule is to be fearful when others are greedy,and be greedy when others are fearful. All day you wait for the pitch you like, then when the fielders are asleep, you step up and hit it. Stay dispassionate and be patient. First the crowd is boozy on optimism and buying every new issue in sight. The next moment it is boozy on pessimism, buying gold bars and predicting another Great Depression. Most people get interested in stocks when everyone else is jumping in. The time to get interested is when no one else is interested. You can't buy what is popular and expect to do well. ABOVE ALL: Whatever God Does, Accept that as Good; Leave Behind ALL Other Judgements/Justific ations. ------------ --------- --------- --------- --------- --------- --------- --------- --------- --------- ------- Disclaimer> Do you homework for your ownself and then invest. My ideas are not advice.
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