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VERSACE: Two steps forward, one step back

- The Washington Times - Friday, May 14, 2010

ANALYSIS/OPINION:

A week ago, I along with the vast majority of investors were staring down one of the worst trading days in recent history. For those not familiar with what I am describing, on May 5 the three major stock indexes - the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite - were down several percentage points before free-falling for 30 minutes to down more than 6 percent for the S&P 500 and nearly 7 percent for the Nasdaq.

As quickly as it happened, those indexes whipsawed back to close the day being down "only" 3.2 percent and 3.5 percent, respectively. This left many scratching their collective heads as to how this happened, how could it happen again and of how can it be prevented from happening again. Concerns over Greece and more caused the markets to contract another 1.5 percent to 2 percent last Friday.

In hindsight, which is of course 20/20 as they say, last weeks column that discussed how volatility can bring opportunity for prepared investors was rather timely. I say this because as concerns over Greece cooled and corporate earnings continued to be strong, the S&P 500 recovered 3.8 percent and the Nasdaq has climbed 6.6 percent as I type this.

Does this mean we are out of the woods yet? Certainly not. If anything, the minimarket meltdown late last week should serve to remind us of the fragility of the current recovery.

Even this past Thursday, the Labor Department reported that initial claims dropped last week by 4,000 to a seasonally adjusted 444,000, which was slightly above analysts' estimates per Thomson Reuters. Despite the modest decline, those initial claims remain at elevated levels. True enough, those figures pale in comparison with the peak of 651,000 first-time claims last year but they are not much below current levels either. As David Resler, chief economist at Nomura Securities, pointed out Thursdays claims figure is the third lowest since Lehman Brothers collapsed in September 2008.

Making this even harder to interpret is the April employment report, which not only showed employers adding 290,000 jobs in April but also an uptick in the unemployment rate despite those job additions. While some companies are hiring, others continue to cut jobs. One such company that is hiring is Cisco Systems, which hired 1,000 new people in the quarter ending May 1 and, per comments from CEO John Chambers, the pace of hiring at Cisco will be picking up.

This positive news is restrained, however, by Dean Foods, the maker of dairy- and soy-related foods and beverages, announced this past Monday it plans to cut 350 to 400 jobs, on top of 150 eliminated earlier this year.

Two steps forward, one step back.

Its possible that this is likely to be the scenario near term.

Consider there were 5.4 million people receiving extended benefits paid for by the federal government in the week ending April 24. The extended federal benefits have added as many as 73 weeks of unemployment on top of the 26 customarily provided by the states. But given the initial unemployment claims data, one has to wonder how many of those on extended benefits will be fining a job near term. But what happens when those receiving extended unemployment benefits find their stipends exhausted? This also raises structural concerns over the economy in terms of job creation versus economic growth, but well save that for another time.

Aside from extended unemployment benefits, other simulative efforts that have or soon will expire are likely to have a cooling effect. As Dean Baker, an American economist and co-director of the Center for Economic and Policy Research, points out, the programs that lifted the housing market, including the tax credit for first-time buyers, have expired and the Federal Reserve is exiting the mortgage market. In Mr. Bakers view, this is likely to push mortgage rates to 5.5 percent to 6 percent by the end of 2010 compared with the current 4.93 percent for a 30-year fixed mortgage per Freddie Mac.

This view of a tougher housing market ahead is corroborated by the National Association of Homebuilders, which sees that "new home sales after April and existing home sales after July are likely to experience some leveling off." As the NAHB rightly points out, "adverse credit conditions will continue to serve as a speed bump in the housing recovery as buyers grapple with tighter credit standards and builders attempt to overcome major impediments to obtaining and renewing acquisition, development and construction (AD&C) loans" will continue to hamper the recovery in the housing market.

Like I said, two steps forward and one step back.

Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston, Va. 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.