The caveat is that after three days of stock-market gains, we have a pretty good idea of what’s to follow in this market. We’re in a trading range, as we’ve explained for some time now; there is no reason to ignore it. A multitude of uncertainties reign down and will affect the market for a while still. These range from questions over the duration of the housing market; to inflation, and thus what Fed policy will look like if this trend does not abate; to across-the-board tax rate uncertainty, weighing heavily on investor sentiment; and geopolitical risks, which will be with us for a long time.
But these situations present opportunities. There are a number of sectors that currently trade at attractive valuations – in addition both large and mid-cap indices will trade at very low levels once the financial sector flattens out --, and thus present strong multi-year return potential. However, we should all be prepared for continued sideways trading and possibly further declines. Patience will eventually pay off though.
Market Activity for August 28, 2008
Back to yesterday’s activity, nine of the 10 major industry groups gained ground; energy shares were the only loser. Financials, industrials, consumer discretionary and basic materials lead the way – health-care and information technology shares also posted nice increases.Crude-oil prices fell $2.42, or 2.05%, to close at $115.73 yesterday even as TS Gustav (soon to be a hurricane, but now only expected to make it to category 2) appears on track to hit Gulf of Mexico energy infrastructure. One reason for the decline was a statement out of the IEA (International Energy Agency) that they would supply strategic stockpiles if needed. This would include the release of stockpiles from European gasoline supplies. The downgrade to cat. 2 also helped a great deal.
On the economic front, GDP was revised much higher, showing the economy grew at a 3.3% real annualized rate – the initial estimate had the figure at 1.9%. We’ll get another revision to the number next month, but it shouldn’t change much from here as all data for the quarter is in by this point.
The components that led to the higher revision were personal consumption, net exports and the change in inventories.
- Personal consumption was revised to show a 1.24 percentage-point contribution to real growth from 1.08 initially.
- The change in inventories subtracted less-than-initially estimated taking 1.44 percentage-points from growth vs. the 1.92 percentage-point drag initially.
- Net exports exploded, offsetting the drag from inventories, adding 3.10 percentage-points vs. the 2.42 contribution estimated last month
Residential fixed investment (housing) was unchanged. This component subtracted 0.62 percentage-point and the main point here is that this is half the average drag of the past nine quarters when the segment was subtracting more than a full percentage point.
Many continue to say current quarter growth will be a payback period for this much stronger-than-expected reading – meaning third-quarter GDP will be very weak if not negative. They cite the fact that the end of rebate checks will cause the personal consumption component to ease. While this may be true, not so much because the ridiculous rebate check scheme comes to a close but simply because income growth has not outpaced the jump in inflation of late (real income growth is flat as both year-over-year income and inflation have risen at roughly the same rate). Thankfully, strong productivity improvements have held back consumer-level inflation more than otherwise would be the case as import, producer and intermediate goods prices soar.
What those predicting a weak Q3 GDP reading may be missing is strong business spending trends and the likelihood this will offset the weakness on the consumer side. Further, even though the drag from inventories was less than first expected in the second quarter, it still posted a large weight on GDP. As business sales continue to rise and inventory-to-sales ratios sit at record low levels, an inventory boost should also help to keep third-quarter GDP somewhat upbeat.
Real year-over-year GDP has increased 2.2% even as residential construction has declined 22.2% -- this illustrates the breadth and dynamism of the U.S. economy.
I’ll note that real final sales (GDP minus inventories) jumped 4.8% last quarter, which followed a 3.9% reading in the first quarter. This final sales figure will ease over the next couple of quarters as inventories rise, and this production will push the headline GDP figure higher.
In a separate report the Labor Department reported that initial jobless claims fell 10,000 to 425,000 in the week ended August 23. This number remains elevated and it’s not good that it remains above the 400k level, but we are seeing some signs that the effect of the government’s program to extend unemployment benefits is waning.
The four-week average for jobless claims did tick down ever so slightly and I think there’s a good chance we’ll see a mild trend lower over the next few weeks. Thirteen states and territories reported an increase in jobless claims, while 40 showed a decrease.
Unfortunately, continuing claims (those on the dole for longer than one week) will remain elevated for a while as the government’s assistance program extended the time (normally 26 weeks) one can collect the hand out.
I’ll leave you today with graphs of real (inflation-adjusted) GDP and after-tax income per capita of the past quarter century.
The charts below are quite enlarged but it was necessary in order to read the percentage increase figures.
Disposable (after-tax) income on an inflation-adjusted basis up 3.0% per year since 1981 – that is huge and explains the level of prosperity we enjoy today.
Have a great weekend and holiday!Brent Vondera, Senior Analyst
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