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VERSACE: Interpreting mixed economic data

- The Washington Times - Friday, October 16, 2009

OPINION/ANALYSIS:

On Wednesday I had the privilege of walking the floor of the New York Stock Exchange as the Dow Jones Industrial Average passed the 10,000-point threshold. To some this is a milestone worth noting, as evidenced by the "Dow 10,000" hats that were being passed around the floor. On the other hand, 10,000 is simply just a number, and without any context does not really inspire any greater confidence in the market.

To be fair, it has been a challenging time for fundamental investors who look to measure the intrinsic value of a stock (or other security) by examining related economic, financial and other qualitative and quantitative factors. At best, the economic data that has come forth has been a mixed bag that in aggregate points to a recovery, albeit a potentially slow and choppy one. The Philadelphia Fed's general economic index dropped to 11.5 in October from a September reading of 14.1, its highest since June 2007. The Fed Bank of New York's economic index soared to 34.6 this month, the highest since mid-2004, from 18.9 in September.

Per the Labor Department, the number of Americans filing first-time claims for unemployment benefits dropped by 10,000 to 514,000 for the week ending Oct. 10, which was modestly better than expected. However, new jobless claims remain above 500,000, which suggests that businesses are not in any rush to bring employees back. If anything, companies such as Dell and others have announced new rounds of layoffs. Early data from the current round of corporate earnings are just that - early. Some are good, such as data from Intel and JP Morgan, but some are not so good, like the data from Nokia and Harley Davidson.

It tends to be the case that the stock market is a forward-looking animal. As signs have emerged that the domestic economy was no longer contracting, the overall market rallied and was led by a few key industry groups. Those groups include basic materials, financials, and industrial, which have all outperformed the move in the broader market indexes. That strong move in the market has many wondering whether the rebound in the market is supported by near-term economic conditions or whether the market overestimated the inflection of the economic recovery? Said another way, are things really getting better or just not getting worse?

In my view, it appears that the economy has found a timid footing, but not one that is surefooted as some might think. More than a few professional investors I have spoken with remain concerned about consumer demand, rising energy costs and the impact of additional cost-cutting initiatives on unemployment, consumer sentiment and consumer spending.

Adding fuel to those concerns is the news from the Social Security Administration that because consumer prices have fallen, there will be no cost-of-living increase in 2010 for the more than 57 million people that receive Social Security benefits. This is the first time since the cost-of-living adjustment program was put in place in 1975 that the benefits have not undergone such a year-on-year increase. To help frame this, those benefit recipients represent roughly 18 percent of the domestic population.

The tea leaves for looking at where the stock market is headed are forthcoming as we march deeper into corporate earnings in the next few weeks. In aggregate, we would expect the vast majority to report revenue declines year on year. Consensus expectations for S&P 500 operating earnings for the September quarter are $14.20, which compares with $16.03 in the prior quarter and $17 in the year-ago quarter.

As important as the rear-view commentary on the September quarter is, the outlook or forward view on the December quarter and in 2010, to the extent management teams will discuss it, is more important in my opinion. That view ahead will confirm expectations or raise concerns over them as to whether S&P 500 operating earnings will be poised for positive sequential comparisons. An upward revision in those earnings would likely propel the overall stock market higher in the near term. Any sense that an upward move that is less than expected is likely to materialize will raise concerns anew.

Ears to the ground, my friends.

Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.