September 2009

We are currently seeing a mix of both positive and negative economic stories almost every day in both print and broadcast media. At times, it can be difficult for the ordinary investor to sort through all of this information and feel as if they have a clear picture of the state of the overall U.S. economy. There are key statistics that are quite helpful in this process—Gross Domestic Product (GDP), the Consumer Confidence Index (CCI), the Leading Economic Index (LEI), data from various governmental agencies, the National Realtors Association housing supply and Case-Shiller Index, and financial statistics like the S&P 500, interest rate figures, and monetary supply.

Major Economic Indicators
GDP is a broad measure of private consumption, investment in production, government spending, and import and export levels. Looking at historic GDP levels greatly helps put this recession in perspective. The two worst economic downturns prior to this one would be those of 1974-1975 and 1981-1982. The downturn of the mid-70’s was brought on by high energy prices in a U.S. economy that was much more entwined with energy prices than we see currently. The early 80’s downturn was notable for its high unemployment rate of 10.5%, a level that had not been seen since before WWII. In both of these recessions GDP fell by 3% for two quarters before a rebound began. We recently saw GDP fall by 5.4% for the fourth quarter of 2008, followed by a 6.4% decline in the first quarter of 2009.¹ (The second quarter of 2009 has seen the decline slow to an estimated 1.0% and a consensus of economists are predicting a positive third quarter figure.) Comparing these GDP figures to previous downturns give a pretty eye-opening picture of how this downturn compares to recent ones with the past 40 years. However, when comparing this to the depression of the 1930’s we do see quite a large difference as GDP declined by 25% within that time frame! While this recession is real, it is not a catastrophic depression.

In addition to the Consumer Confidence Index that one often hears about, the Conference Board publishes a Leading Economic Index. This is a well-respected source of economic data that points to the status of the broad U.S. economy. Their latest release covers data through July and shows 6 of their 10 indictors increasing.² This is the fourth consecutive positive LEI data release. Given the doom and gloom still heard in retail sales, credit, and the housing markets, what is driving the increase of the LEI? The spread between short and long-term interest rates has decreased, highlighting the return to more normal lending practices from the more restrictive environment we had seen earlier this year, new unemployment claims are down, manufacturing hours worked are up, vendor performance has improved, stock prices continue to increase, and orders for durable goods are increasing. In total, these factors have contributed to an index reading of 101.6, where the 100 baseline is a picture of the economy in 2004. Furthermore, a 6-month reading of the index through July shows 8 out of the 10 areas of the economy measured increasing!

Industrial Production
We have seen a number of changes to industrial production over the year. At the beginning of 2009 many companies quit adding to inventory, planning on pulling from existing product to fill orders in a slow economy. Inventory has now been depleted and companies are having to add to their inventory in order to fill orders. This has been seen in Industrial Production posting its first increase since last Autumn with a 0.5% increase in July.³ Much of this positive change was due to a 43% increase in light vehicle assemblies from June to July. A similar increase was seen in capacity utilization (the amount of manufacturing resources actively being used to create goods). While such a slight increase in production and capacity numbers may not sound like much, this is the first increase we have seen in these figures since December 2007 and is one of the first places where we will see signs of the recession lifting. Orders of the durable goods category were up 4.9% in July, the greatest increase in the past two years.⁴ One month does not make a trend, but the halt of the decline of these numbers is positive. I would note that the capacity utilization figure is at a comparatively low level and will be a factor in keeping inflation in check for the near future.

Productivity
Worker productivity for the second quarter (April-June) grew at the fastest rate seen since late 2003.⁵ This led to the largest decline of labor costs seen in 8 years—down 5.8% for the quarter. A portion of this decrease in costs is due to lower employment and workers still employed making up for the loss of other employees. However, improvements in technology use, including the internet, have contributed greatly to the overall gain in worker productivity, and the resulting long-term decline in labor costs.

Housing
Sales of existing homes rose 7.2% in July.⁶ This is the fourth straight month we have seen an increase in this figure, and includes a good number of first time home buyers. New-home sales rose 9.6% in July. Again, the fourth month we have seen an increase in this figure. The national housing inventory is now down to a 9.4 month supply from the high of 11.0 months inventory seen in November 2008.

Future Outlook
International economists recently met for the Federal Reserve Bank’s 2009 Annual Symposium and renewed an international commitment to low interest rates for the near future.⁷ Low interest rates will continue to provide operating capital for business growth and the funds for consumers to purchase homes and big ticket manufactured goods, both key to easing the recession. Deflation stands at 2.1% over the last 12 months as of July.⁸ Energy alone is down 28%! There is no indication that this situation will change in the short-term and is helping households and businesses feel that they can afford to purchase goods and services.

A good number of respected economists are predicting GDP growth of up to 2-3% for 2010. According to this estimate, the S&P 500 would then be trading at a price earnings (P/E) multiple of just 14.3, a number on the low end as P/E figures have typically held in the 12-18 range.⁹ I would note that the market has seen a 52% increase from the March 9th low through yesterday’s September 8th close and is now trading back at levels seen before the large downturn last October.¹⁰ While we have not yet returned to the prices figures seen before the beginning of the recession, there is no reason to assume prices will not continue their upward trend longer term. I would not expect to see prices jump overnight, but continued measured growth does appear to be a realistic expectation. I would note that money market funds still hold $3.58 trillion that investors can use to buy stocks, bonds, and mutual funds as they again feel more comfortable with market growth prospects.³ This does not count the amount of cash that investors also hold and may use to reenter the market.

Finally, although orders for big ticket items are up (as seen in the industrial production figures previously mentioned), consumer borrowing has declined dramatically.¹¹ Consumer credit (excluding mortgages and home equity loans) has declined by 10.4% annualized as of July. This time frame does include the beginning of the Cash for Clunkers program that analysts had expected to increase borrowing. While this is not good news for much of the retail sector, it is a healthy change in the overall economic picture as far too many consumers had taken on more debt than they could afford over the past decade or so. This trimming of debt and change towards healthier consumer spending habits will be a great positive for the broad economy if consumers continue along this path of more conservative consumption levels.

I feel that a good portion of Americans with 401k plans and other investment accounts exited the stock market at some point during the last year. Based on what I have observed, it appears that many Americans simply look at their investment accounts and upon reaching a given personal threshold say “I want out.” While exiting the market may make one feel more secure, the bigger question is when will they reenter the market. While we all certainly have to pay attention to our personal comfort levels, making financial decisions based more on emotion than empirical analysis tends to leave investors with less than optimal outcomes. The market reached a low point on March 9th and has recovered significantly since then. It is hard for many people to understand how the unemployment rate can continue to rise, yet the stock market is gaining ground. I would point out that in the most recent economic downturn (the technology based decline of 2001-2002), the stock market began a broad recovery in March of 2003, but it wasn’t until mid-2005 that we saw a broad increase in employment figures. This is typical recessionary behavior and is why unemployment is termed a “lagging indicator”—a set of data that points to past economic conditions rather than future ones.

Although we still are feeling the effects of the recession in higher than usual unemployment numbers and still see some problems within the housing sector with continued foreclosures, the picture of the overall economy is becoming brighter. A broad array of corporations are making money, about 90% of workers have jobs, energy prices have—with natural gas prices falling substantially, and new home buyers are willing and able to enter the housing market.

1) http://www.bea.gov/newsreleases/national/gdp/2009/pdf/gdp2q09_2nd.pdf, page 5

2) http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

3) http://www.federalreserve.gov/releases/g17/Current/default.htm

4) http://online.wsj.com/article/SB125235908101190669.html#mod=todays_us_money_and_investing

5) Bob Brinker’s Marketimer, Vol 24, No.9 Sept. 3, 2009 page 1

6) http://www.realtor.org/press_room/news_releases/2009/08/strong_uptrend

7) http://www.economist.com/businessfinance/displaystory.cfm?story_id=14258996

8) http://www.bls.gov/news.release/cpi.nr0.htm

9) http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS

10) http://online.wsj.com/mdc/public/npage/2_3051.html?symb=SPX

11) http://www.msnbc.msn.com/id/32737999/ns/business-stocks_and_economy/

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.