WEEKLY UPDATE

March 8, 2010

Don't Worry about a Double-dip in the Economy - If/When it Arrives, We're Ready for It

Some of TV's more popular talking heads are now giving airtime to the question, "Is the economy headed for a double-dip?" We have been talking about a double-dip in the economy for some months now. It doesn't take too much effort to see why a double-dip could be in the cards: banks are still too unhealthy to lend, we are still losing jobs, and the government is pulling away many of the stimulus plans it enacted a year ago to prop up the economy. Each of these alone puts the economy on shaky ground. I wrote about the Fed's three-year outlook for subdued growth just a couple of weeks ago, but today we will take a closer look at what one private group is saying about the economy.

The Consumer Metrics Institute Forecasts a Decline in the Economy

The chart below comes from the Consumer Metrics Institute, a private economic forecasting firm. The CMI uses a data collection method that gathers U.S. economic information on a real-time basis - a much timelier approach than that of the Commerce Department, which is notoriously slow at revealing turns in the economy.

This chart (Figure 1) compares the CMI's real-time economic growth index to the U.S. Department of Commerce's quarterly GDP growth rates for the past four years. The CMI's data suggests that a downturn in consumer activity started last August, and because there has been a four-month lag time between consumer activity and activity in factory production, we are only now starting to see weakness re-emerge in factory output and employment. The employment chart (Figure 2) below shows a peak in job growth in November followed by more declines; this supports the CMI's view that the economy peaked in November.





Meanwhile the Commerce Department Index of Leading Economic Indicators dropped significantly on January 15th and reached a net annualized "growth" rate of -1.5% by the end of February. Further making the case, the Commerce Department announced the results of the Consumer Confidence Survey on February 23rd which dropped 10.5 points from the January reading. They went on to report that "current business conditions and the job market pushed the Present Situation Index down to its lowest level in 27 years." All of this is pointing to a slowdown of reported economic activity over the next few months.

The Official Unemployment Rate Stays Steady at 9.7% with 36,000 Jobs lost in February

The Bureau of Labor Statistics (BLS) reported that non-farm payroll employment was down 36,000 jobs in February. Employment fell most in construction and information services, while temporary help services added jobs to the economy. Among the highlights:

- 36,000 jobs were lost vs. 26,000 lost in January.
- 64,000 construction jobs were lost vs. 77,000 last month.
- 51,000 (50,000 were part-time) professional and business service jobs were added vs. 30,000 added last month.
- 48,000 temporary help jobs were added vs. 50,000 added in January.
- Average weekly hours slipped from 33.9 hours worked each week to 33.8 hours.


People Not Included in the Numbers

About 2.5 million people have lost their jobs but are not included in the unemployment rate because they have not actively looked for work in the past 4 weeks; this figure is up 476,000 from a year ago. Among these 2.5 million people, 1.2 million of these folks are "discouraged workers" because they believe that no jobs are available for them.

The chart below (Figure 3) shows the offical unemployment rate (U-3, 9.7%) and the broader (U-6, 16.8%) unemployment rate which is the offical unemployment rate plus those folks who gave up looking for a job, those whose unemployment benefits ran out, and those working part-time but desire a full-time job. The SGS alternate figure is based on the way unemployment was calculated before it was changed in the mid-1990's.



The key takeaway from all this is that there are 8.8 million people who are looking for work today and countless more working part-time. Part-time jobs will have to begin turning into full-time jobs before the unemployment rates decline and the economy begins a sustained recovery.

Our Outlook for Next Week

U.S. stocks had a good week. Most of the gains in the stock market could be attributed to favorable news concerning Greece (i.e. a successful Greek bond auction and further talks of a bailout from the European Commission) and the better-than-expected U.S. unemployment figures released on Friday. Technical analysis points to a little more strength in the stock market.

Bond yields (Figure 4) for 2 and 5-year U.S. Treasuries have been trending lower (with prices trending higher) since January 1st, but the unemployment figures sparked a mild pullback in some sectors of the bond market. Those of you who were under-allocated in bonds saw us take advantage of these weaker prices by buying some selected bond funds. For now the trend in interest rates is neutral. Signs of economic growth may cause rates to rise, but as I indicated at the top of this week's update, time will tell if and when a double-dip of economic weakeness surfaces. If it does, it will be bullish for our credit-worthy bonds.



All in all our positions are squared up to endure the economic conditions we now face. A double-dip economy may be in our future, but we are prepared for it.

Take care,
Greg

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March 1, 2010



It was a tough week for economists to find bright spots. Fed chief Ben Bernanke set the tone on Wednesday when testifying before the House Financial Services Committee. He told the committee that the U.S. economy is in a "nascent" recovery and that interest rates near zero are still required. This was followed by the release of some troublesome economic data that was consistent with his outlook.

Unemployment claims come in higher than expected for the second week in a row
This week's new unemployment claims report showed nearly 40,000 more people had filed for first time unemployment support. The Labor Department said new claims for unemployment insurance rose to a three-month high and this was the second week in a row that new claims of unemployment came in higher than expected. Economists thought new claims would be down to nearly 400,000 by now, instead new claims are currently at 496,000.

New orders for durable goods unexpectedly drops
Orders for durable goods excluding transportation unexpectedly fell 0.6%, the biggest drop since August, while a measure of bookings for business equipment showed its largest decrease in nine months, the Commerce Department said this week. What makes these figures even more disheartening is that defense spending by the Federal government is holding up the durable goods figures more than ever before. On average defense spending has made up 4.4% of overall durable goods spending but since December 2007 defense spending has been increasing to a level today of more than 8% of durable goods spending. If we took away the defense department durable goods spending, we could see just how weak the private sector really is.

New and existing home sales plunge
Sales of new homes in the U.S. unexpectedly fell in January to the lowest level on record, a sign that an extension of government tax credits may not be enough to rekindle demand for housing. Folks on the business networks began to discount this information saying who wants to buy a new home with so many cheap existing homes on the market. That may be true but their argument that buyers were avoiding new homes to favor existing homes fell apart when it was reported that existing home sales also plunged. Existing home sales fell an unexpected 7.2% in January showing that this housing recovery is a lot shakier than most had anticipated.

So… with all this weak economic news, how did stocks and bonds perform?
As the chart below shows, stocks were lower for the week. Much of the weakness in stocks came naturally as a result of the weak economic data, but recent moves in stock prices also have a lot to do with the strength of the dollar. From Monday through Thursday morning the dollar held firm against the Euro and lately a stronger dollar means lower stock prices. But after reaching an eight-month high against the Euro, the dollar started to weaken on Thursday morning and this put a floor under stock prices. As we start next week any further signs of Euro strength will likely put a boost into the stock market which I doubt will last long as a bailout of Greece will only delay the decline in the Euro against the greenback.

Meanwhile treasuries had one of the best weekly gains since last August
Yields on 2-year Treasury notes closed the week at 0.82% down from 0.92% a week earlier. "The fundamental picture is supportive of Treasuries as the recent housing data highlight how the U.S. economy may be unable to move down the road without government training wheels," said Bill O'Donnell, head of Treasury Strategy at RBS Securities.

The chart below shows the past week in trading for the Dow compared to the dollar index (UUP) and the mortgage-backed bond market (MBB).



The bottom line is that we need to keep our jackets on while this snowstorm of economic weakness continues to dampen the hopes for a quick economic recovery. Talk of economic green shoots may soon be replaced with concerns that we are in the beginning of a double-dip. Our approach remains cautious.

Take care,
Greg