Latest Econ Data Not All Doom and Gloom

by Dan Burrows | July 3, 2012 6:30 am

The latest reading on U.S. manufacturing[1] bolstered the bearish case that the economy is stalling out and getting precariously close to another recession.

Too bad no one told the stock market.

Yes, the Dow Jones Industrial Average opened about 70 points lower on the news, but that’s a pretty restrained response, especially after recalling that it rallied nearly 300 points to end last week. When the day was done, the Dow slipped a mere 9 points, while the broader S&P 500 picked up 3 points with a late rally and the tech-heavy Nasdaq Composite turned positive by mid-session and closed 16 points higher.

If the outlook for the economy and corporate profits is really so dire, why has the U.S. stock market returned more than 8% halfway through the year? That’s a performance any investor would take over the course of any entire year, especially in the absence of inflation eroding any gains.

To be sure, the news out of the Institute for Supply Management was bad. The manufacturing index fell below 50 — indicating economic contraction — for the first time in three years. Uglier still, the new-orders index logged its steepest drop since the month following the terrorist attacks of September 11, 2001.

But the sky is hardly falling. Not yet.

For one thing, the ISM’s index hit 49.7, a nasty number, yes, but one that’s not — repeat, not — associated with recession. The index has to fall below 47 to be consistent with another recession.

Furthermore, according to ISM, a reading of 49.7 is actually just about the right for the sluggish but positive rate of economic expansion we have. Indeed, it’s actually a bit better than what we’ve seen so far this year, since ISM says the latest reading is consistent with GDP growth of about 2.4%.

That’s actually a tiny bit better than economists’ average forecast for U.S. GDP to increase 2.3%[2] in 2012. And it’s a heck of a lot better than the current pace of 1.9% annualized growth seen in the first quarter.

In other words, the latest ISM data didn’t really tell the market anything it didn’t already know. (It also helps that manufacturing accounts for less than 20% of gross economic output and less than 10% of the work force.)

Besides, some parts of the ISM report — and a separate piece of data on construction — were OK-to-good news. True, the ISM’s production index component fell steeply, but it still remained above 50, indicating all-important expansion. Additionally, the employment index ticked down only slightly to remain fairly resilient at 56.6.

At the same time, data on construction blew past economists’ forecasts — a bullish sign, indeed. Spending on projects jumped 0.9% in May, the Commerce Department said, versus an estimate of just 0.2%. Even more promising, the gain was driven by residential construction and the private sector. (As has been the case throughout the recovery, state and local government spending actually acted as a drag.)

The construction data dovetails nicely with the better-than-expected housing data we’ve been treated to lately. And a combination of better housing data and lower gas prices are good for both the economy and share prices, notes Jeffrey Saut, chief investment strategist at Raymond James Finanical (NYSE:RJF[3]).

After all, the pickup in homebuilding would not only add jobs, but should strengthen future GDP numbers, Saut says in his latest report to clients. Meanwhile, the decline in gas prices is “tantamount to a huge tax cut since every one penny decline in price adds approximately $1 billion to consumers’ purchasing power.”

Given those forces, among others, Saut expects the summer of 2012 to become a case of deja vu all over again.

“I expect the same outcome that occurred for the past two summers,” Saut says. “That being, recession fears, which caused those previous mid-year declines in equity prices, should give way to no recession with an attendant rise in equity prices.”

As of this writing, Dan Burrows held none of the securities mentioned here.

Endnotes:
  1. latest reading on U.S. manufacturing: http://investorplace.com/2012/07/june-manufacturing-falls-may-construction-spending-up/
  2. forecast for U.S. GDP to increase 2.3%: http://investorplace.com/2012/06/q3-economic-outlook-more-muddling-through/
  3. RJF: http://studio-5.financialcontent.com/investplace/quote?Symbol=RJF

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