Material, financial, energy and industrial shares led the broad market to a fractional gain. (Commodity prices are on fire this morning on a another good factory number out of China, which we’ll touch on below, with Dr. Copper up 4.5% and crude back above $70 per barrel; this should keep the rally in basic materials and energy going).
The Dow Average added 17 points thanks to a big day from Chevron. The NASDAQ Composite slipped as the index was pressured by tech shares. Mid cap stocks registered a fractional gain, while small caps declined.
Second-quarter GDP (initial estimate)
The Commerce Department reported their initial estimate to Q2 GDP came in at a much-better-than-expected -1.0% at a real annual rate, yet the previous two reading (Q1 and Q4 2008) were revised lower. That doesn’t matter right now as the market looks forward but it’s a reminder, as if we needed one, of the severity of this downturn.
We’ve now contracted for four-straight quarters. Prior to this recession we have never seen more than two-consecutive quarters of decline in the post-WWII era and the previous two readings of -6.4% and -5.4% are far and away the most harsh two-quarter decline since the 1957-58 recession (-4.1% in Q4 1957 followed by -10.4% Q1 1958).
Economic activity was buoyed by a 5.6% jump in government consumption that added 1.12 percentage points to the figure – much more of this to come – and net exports, which added 1.38 percentage points to GDP. Exports actually fell 7.0%, but imports fell more, down 15.1%. (The decline in real exports of 7% was a vast improvement from the 29.9% plunge in the first quarter. Real imports fell 15.5% at an annual rate, big move down that speaks to the troubled in consumer land but much better than the slump of 36.4% in Q1)
And speaking of the consumer, the largest segment of GDP – personal consumption – fell for a third quarter in four (that’s never before occurred since records began in 1947), down 1.2% at an annual rate. This followed a 0.6% rise in Q1, a 3.1% slide in Q4 and a 3.5% slump in Q3. (That Q1 rise of 0.6% was revised down from 1.4%, which was revised down from the initial 2.2% estimate that had the press giddy that the consumer was back. Oh, I wish it were true.) Personal consumption subtracted 0.88 percentage-point from real GDP. Durable goods shipments got slammed by 8.1% last quarter, which is what led the segment lower. Non-durables fell 2.5%.
Business investment (structures, equipment and software) fell 8.9%, normally a large move but not compared to the record 39.2% collapse of the prior quarter. Non-residential structures decline 8.9%. Equipment and software fell 9.0% --this reading was down 36.4% in the first quarter.
One should expect a statistical bounce from business investment for the current quarter, as we discussed after that last durable goods report. Business investment subtracted 1.82 percentage-points from the GDP reading.
Inventories, which many expected to rebound, fell for the sixth quarter in seven, down $141 billion at an annual rate, which put the two-quarter reduction at $250 billion – by far a record decline. Again, we will se a statistical bounce in GDP as the inventory dynamic catalyzes growth – simply put, there must be some ramp up in production after a slashing of inventories such as this.
And this is where the meat is for the next two quarters. Massive inventory liquidation and the small reduction in real final sales of just 0.2% in Q2 – final sales is GDP less inventory change – sets up for that inventory dynamic to rush through the pipeline. (Although the timing of this statistical bounce is fairly uncertain by way of the Chicago manufacturing number discussed below, it may not occur in the third quarter as we currently expect; we’ll just have to see how things progress over the next two months)
A statistical rebound does not make for a sustained recovery, we must see final demand come back and businesses must begin to spend again. In addition, all of the government spending in the world cannot fully offset weak consumer and business consumption. It can foster a three-four quarter increase but not much beyond that.
Residential fixed investment (housing) subtracted from GDP for the 14th straight period, down 29.3% at an annual rate last quarter. The segment reduced GDP by 0.88 percentage point.
This downturn has been severe and the damage done to the consumer will take some time to work out, putting a drag on GDP in the coming quarters. Over the next two quarters, its appears the inventory dynamic and net exports will offer a boost to growth, followed by a reading that more closely resembles something more typical of expansion in the fourth (its four–six weeks to early to throw out an actually number.) Government spending will keep the “dream” alive for the first two quarters of 2010 (most of the stimulus spending will kick in next year) but after that the expansion will peter out as the pay back for the way we’ve attacked this contraction will come due.
The economic rebound needs to be put into perspective, even if we get one, maybe two, 4% readings (although unlikely with unemployment this high and tighter credit standards) these would still be weak numbers coming out a contraction such as this – normally you see a 6.5%-8.0% bounce after rough recessions.
The way I see it the recovery will be similar to the 1980 recovery in terms of its short duration. Notice how the bounce back in GDP is strong after a deep contraction (such as the 1961 recovery following the rough late 1950s contraction, the 1975 recovery following the harsh 1974 recession and the 1982 recovery). I have my doubts that this one will be followed by a strong 6.5%-8.0% quarter even with the huge stimulus money set to roll in 2010
Chicago Purchasing Managers Index
In the day’s other release the Chicago PMI showed manufacturing in the nation’s most significant region improved for a second-straight month. The index rose to 43.4 for July after a 39.9 print in June. While the gauge remains in contraction mode – a move above 50 marks expansion – it is being weighed down by the auto sector. As production come back in autos this reading should move above 50, call it September when it moves back to expansion is what I’m guessing.
Most sub-indices of the report suggest things continue to improve, however, the inventory reading is disturbing as it got slammed back to 25.4 – a record low.
The Rally Rolls
Stock-index futures are up big this morning on last night’s news that China’s manufacturing sector remained in expansion mode for the fifth-straight month. China’s PMI (equivalent to our ISM manufacturing report, which we’ll get this morning) came in at 53.3 for July (a number above 50 marks expansion). While the figure is not raging to robust levels, pretty much holding at this 53 level, the Chinese government is pushing banks to lend aggressively. I haven’t seen the latest number, but the previous reading on credit expansion showed lending tripled from the year-ago level. So long as this is the case, China’s PMI will continue to grow, even if it means big banking trouble down the road.
If U.S. manufacturing shows additional progress toward that 50 mark, we hit 44.8 in June after 42.8 for May, and hit or surpass the estimate of 46.5 when this morning’s figure is released, we should make a run today for 1000 on the S&P 500.
Have a great day!
Brent Vondera
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