Comstock Partners, Inc.May 26, 2011
More Confirmation Of The Economic Slowdown
Our comment of two weeks ago outlined the major headwinds likely to impact both the economy and stock market over the period ahead, while last week's comment discussed the actual economic slowdown that was already happening. Events of the past week have confirmed these views.
The Chicago Fed's National Activity Index of 85 coincident indicators for April dropped to minus 0.45, its lowest level since last August. The index has now been below zero for five of the last eight months, as is the three-month moving average. This means that the economy was probably growing below trend in the first quarter, and possibly the second as well.
First quarter revised GDP growth was not revised upward as the consensus expected, but remained at the originally reported 1.8%. Moreover the underlying data deteriorated as consumer spending growth was revised down to 2.2% from 2.7% and inventory accumulation was revised up by $9 billion. Furthermore, major firms have been reducing their second quarter GDP growth estimates to well below 3%. Recall that toward the end of 2010 most pundits were looking for 4% growth in the quarters ahead.
Initial weekly unemployment claims, reported today, rose to 424,000 and have now remained well above 400,000 for the seventh straight week after a period of coming in below that level. This does not bode well for upcoming monthly payroll employment.
The ECRI Weekly Leading Index was down again last week, the fourth decline in the last six weeks, and the lowest since the week of January 15th. A slowdown in this indicator generally suggests a period of tepid growth in the period ahead.
The May numbers for both the Richmond and Kansas City Fed indexes fell sharply, confirming the previously reported results for the Philly Fed and the Empire State Manufacturing Survey. This strong unanimity strongly suggests that industrial production is still extremely sluggish in May. These results are consistent with the April decline in core capital goods orders of 2.6%. Similarly, shipments dropped 1.7%.
Keep in mind that this has happened during a period where QE2 poured reserves into the financial system, the stock market rallied and fiscal policy was boosted by the reduction in payroll withholding. With all of that, we have an economy that is growing below trend and fading rapidly. Now QE2 is ending within weeks, fiscal policy is about to tighten and housing prices are still falling with lots of additional supply still coming.
The stock market has now stalled for over three months and appears to be in the process making a top. The S&P 500 reached an intra-day high of 1344 on February 18th, backed off and then broke out to a new high of 1370 on May 2nd. It has since declined to well below the 1344 mark, a strong indication that the breakout has failed and that a new decline may be underway. This would be similar to the pattern of 2010, when the market dropped 17% following the end of QE1. That time the market was saved by the initiation of QE2. The Fed, however, is running out of ammunition, and we doubt that a QE3, if ever implemented, would be that effective.