Daily Insight

Stocks finished the week strong as better-than-expected employment data gave investors reason to believe the recession is over. Nine of ten sectors gained, with the only loser in the broad-based rally being the energy sector. As you can see below, all domestic equity asset classes made solid gains but I want to make special note of REITs’ performance since they are not listed in the table.

REITs (real estate investment trusts) had a particularly impressive performance last week (up 16.80%) as investors anticipate some of the financially stronger REITs to shift from defense to offense. Faced with a deteriorating commercial real estate market and hundreds of billions in debt coming due in the next few years, REITs have generally been shunned by investors in 2009. However, REITs have been raising capital by slashing dividends, issuing new equity, and buying back their public bonds at steep discounts. Financially strong REITs have offered attractive yields for several months, but now REITs are getting a boost from investors as they prepare to unleash billion dollar-war chests to fund acquisitions of troubled properties on the cheap. To read more about this, check out my post on our blog from last week by clicking here.

Market Activity for August 7, 2009
Dissecting Friday’s Data

Much to everyone’s surprise, the unemployment rate actually fell in July, hitting 9.4% from 9.5%. Although this report continues to support the view that the recession ended in the summer of 2009, the decline in the unemployment rate was not a product of job creation, but rather due to people dropping out of the work force. If people drop out of the labor force, the unemployment rate can decline because fewer people would be considered jobless.

The July household survey showed the civilian labor force shrinking by 422,000 and employment falling 155,000. That translated into 267,000 fewer people listed as unemployed. The labor-force participation rate fell 0.2 percentage point in July to 65.5%. Once the economy improves, these people will likely return to the workforce, which will result in the unemployment rate climbing higher – for example, people who decided to return to school during the downturn will eventually return to the job search and help push unemployment higher.

Another factor that could keep the unemployment rate elevated is the considerable degree of structural unemployment, evidenced by the 53.5% of those unemployed because they have lost their jobs permanently – the highest figure since this data has been tracked. Structural unemployment, as opposed to cyclical unemployment, is caused by changes in the economy rather than the business cycle. The high number of people permanently laid off reflects the excess capacity that had developed in the economy over recent years in areas such as construction, financial services, retail trade, and auto production/sales. Even as the economy recovers, these displaced workers will likely be unemployed for a prolonged period.

The point to take away here is that we shouldn’t get ahead of ourselves. The improving trend of the labor market cannot be denied, but businesses are not about to start hiring people. Businesses will want to make sure that a sustained economic recovery is here before doing any substantial hiring. For this to happen, demand will need to improve – a process we believe will continue to be a slow one as households contend with weak income growth and balance sheet issues for some time.

Speaking of consumers’ balance sheet issues, the Friday’s consumer credit report showed borrowing by U.S. consumers dropped in June for the fifth straight month, the longest series of declines since 1991. Consumer spending, which accounts for about 70% of the economy, will take time to recover as households put off major purchases in light of a weak job market, stagnant wages, and falling home values.


Where do we go from here?

It seems like a long time ago when stocks were priced for the possibility that the global banking crisis would shut down the world’s financial infrastructure. Being a forward-looking indicator of the economy, stocks rallied since March in anticipation of the end to the recession. But it’s a bit of a head scratcher that stocks are now rallying because the recovery that stocks themselves predicted comes true.

The point I’m trying to make here is that it’s easy to be greedy here and pretend that the crisis never happened. But, it did happen. As a result, the financial system was left crippled and the government has taken on trillions in debt which will threaten the world economy with inflation and higher tax rates. I’m not necessarily saying that stocks can’t continue their progress – although they seem overdue for a small correction following the 50% jump from the March lows – but it would be foolish to think everything is back to normal and stocks will quickly return their 2007 highs.

Patience and discipline is crucial for all investors in this environment.


Have a great day!


Peter J. Lazaroff, Investment Analyst