With core inflation down and interest rates up, prospects for the U.S. economy are dimming. Offsetting positive and negative developments left stocks unchanged this past week. Although the economic news may appear mixed, we believe business is slowing more than some of the news reports would suggest.
The Week That Was
The government on Friday released second-quarter GDP data, the most comprehensive
measures of our economy. They show second-quarter economic activity slowed, with inflation receding to a 3 percent annual rate.
There are two measures of overall economic activity. One is the popular GDP measure of
spending. The other is the GDI (gross domestic income) from production. Conceptually, they equal each other. In practice they often differ slightly. That has happened in the current case. Second-quarter GDP increased at a 3.8 percent annual rate while total -ncome GDI increased at a 2.4 percent rate.
Averaging the two is probably the best guide to the current dollar rate of spending and income. That indicates the economy slowed to a 3 percent rate (including inflation) between the first and second quarters.
This is a significant slowing from a year ago, when both of these measures were increasing at slightly above 8 percent rates.
Things to Come
Later today and on Wednesday, S&P and ISM will report on September business conditions. August surveys pointed in sharply different directions. We can hope that the September daa will provide more clarity. We expect more signs of weakness.
Friday brings the September jobs report. The consensus expectation is for another strong, 150,000 increase in employment.
With government scaling back subsidies and living standards declining, we anticipate continued growth in monthly private payrolls in the vicinity of 100,000 to 150,000 workers.
Market Forces
The economic news was mixed last week. Friday’s positive inflation news had the Fed’s
favorite core inflation rate for August at a 1 percent annual rate and 2 percent for the past three months.
Stocks responded to the inflation news by bouncing higher, and longer-term interest rates eased.
However, some technical indicators have turned extremely negative. Small cap ETFs (IWM, IJR) have fallen well below their 200-day moving averages. The Dow is struggling to stay above its 200-day average of 33,800, though the Nasdaq remains well above its key 200-day average.
Last week’s main development was a sharp rise in longer-term interest rates, with Thursday’s 10-year T-Notes hitting a new high of 4.6 percent.
Friday’s August report on spending and income continued with the same mixed messages noted in the July report. Consumer spending and wages soared, while personal income slowed and real disposable income declined.
Spending was strong, but the incomes needed to sustain spending were weak. We place more importance on income and production a than spending. Consumers can only draw on savings and increase debt for so long.
Next month’s third-quarter GDP report may show the economy growing, but beneath the surface it continues to weaken. As the lagging effects of money restraint continue to bite, look for more signs of weakness to surface.
Optimistic investors might view signs of a weak economy as a reason to anticipate an easing in monetary policy. We doubt the Fed will be in a position to ease monetary policy at any time in the near future. Hence, we continue to anticipate the likelihood of further downward pressure on stocks.
Outlook
Economic Fundamentals: restrictive
Stock Valuation: S&P 500 overvalued by 12 percent
Monetary Policy: restrictive
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