Opinions Investor's Corner John Gudritz's Investor's Corner: It is like déjà vu all over again
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Investor’s CornerBy John Gudritz CFA
Principal
Front Street Investment Management LLC
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If it seems like there is something strangely familiar with what has been recently happening in the economy, it is because we have seen it before. Most of the concerns that have caused the current decline in the stock market and interest rates are almost exactly what investors were worried about a year ago when the market fell about 16 percent from its April high. As Yogi Berra once said, “This is like déjà vu all over again.”
Last year at this time I said that my biggest concerns about the outlook for future economic growth were the declines in two major leading economic indicators; the Economic Cycle Research Institute’s (ECRI) Weekly Leading Index and the Conference Board Leading Economic Index (LEI). It was very disconcerting to see the leading indicators decline after only one year into the economic recovery.
Well guess what. After having turned around in the third quarter of 2010 and risen through the first quarter of 2011, these leading indicators are falling once again.
The ECRI Weekly Leading Index has declined steadily over the past six weeks. Lakshman Achuthan, the managing director of ECRI, recently stated that “a global industrial slowdown is now looming, according to ECRI’s global long-term leading indicators, and that includes the U.S.”
The LEI fell .3 percent in April 2011, which was the first decline since June 2010. The Conference Board economist Ken Goldstein said in the news release that “economic growth will likely continue through the summer and fall but the pace of economic activity may be choppy.”
So, at least at this point in time, neither forecasting organization is calling for another recession any time soon. However, when the economy is only growing at a rate of 2 percent or less it does not take much of a headwind to bring it to a halt.
Other similarities between now and a year ago include the decline in the latest Institute of Supply Management’s (ISM) Purchasing Managers Index. This index, which reflects the strength or weakness in manufacturing, peaked in February and has fallen for the last three months. Again, at this point it is only suggesting a slowdown, not a recession.
Most economists are pointing to the parts supply interruptions caused by the severe earthquake and tsunami in Japan as the primary reason for the decline in U.S. production. In fact it was a major factor for the weaker sales in May for the automobile industry. However, I think there are additional reasons for this economic slowdown.
For example, the significant rise in commodity prices, especially gasoline and food, limited the increase in consumer spending in the first quarter of 2011. As a result, real GDP growth slowed to only 1.8 percent from 3.1 percent in the fourth quarter of last year. That could continue if gas prices remain high.
Also the Conference Board Consumer Confidence Index remains at recessionary levels and near where it was a year ago. The reality is that most people on the street have not yet experienced the economic recovery that they read about in the newspaper.
The employment situation is suddenly looking similar to last year too. After averaging about 200,000 a month since February, job gains suddenly declined to only 54,000 in May. A year ago the employment gains went from a three-month average of about 300,000 per month through May to an actual 200,000 decline in jobs in June. The 9.1 percent unemployment rate today is only slightly less than last year’s rate of 9.5 percent.
The housing market has actually gotten worse from a year ago. Sales are down and home prices have officially “double-dipped.”
As in 2010, there are still concerns about sovereign debt restructurings (a.k.a. defaults) in Greece and the same other weakest links in the European Union. What is different this year is that the United States is now on the “watch list” of the bond rating companies like Moody’s for a downgrade in its debt rating.
Like last year, the U.S. economy is slowing down at the same time that the Federal Reserve’s quantitative easing policy is coming to an end. That has investors wondering if we will see QE3 with the hope that stocks will continue to rise.
While QE2 gets a lot of credit for the higher stock prices, it was the growth in corporate revenues and earnings that provided fundamental reasons for the stock market rally. QE2 supplied a supportive monetary environment for investors by demonstrating the Fed was focused on improving the economy.
QE3 would provide that same friendly message to the markets but the effect on stocks would continue to depend on what is happening in the economy. That may now be beyond the Fed’s ability to help. My concern is that the structural debt problems in the U.S. make us vulnerable to more than just a slowdown.