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VERSACE: Sit back and hold on for a bumpy ride

- - Thursday, September 9, 2010

ANALYSIS/OPINION:

While the formal end of summer is still a tad away, the Labor Day weekend and back to school signal a return to business as usual for most if not all of us. For us investors, that means taking stock of recent data and interpolating what that collection means. I think it is even more important now that we pay attention to what the data tell us for the simple reason that we are in the midterm election cycle. Like it or lump it, a number of candidates are going to make certain assertions about the state of the economy, job creation and other ideas that are likely to sway voters and the stock market.

As I have always maintained, we need to understand the data so as to avoid a potential head fake in the market — my thinking is it's better to sit on the sidelines than be the victim of whipsaw action in the market.

It would seem I am not alone in this thought.

Trading volumes have been lower as evidenced by average trading volume for equities traded on the New York Stock Exchange and other exchanges, which to me signals a lack of conviction in the upward move in major market indexes in the past several trading days.

Case in point, average daily trading volume for all cash equities, read that as stocks and exchange traded funds (ETFs), fell 21.8 percent in August 2010 compared with August 2009. But one trading data point a trend does not make, so let's go back a few months.

In doing so, we find that average daily volume for NYSE Euronext cash products handled in July 2010 decreased 7.2 percent compared with July 2009 and fell 13.1 percent from June 2010 levels. During those three months, the S&P 500 has been on a roller-coaster ride, but it has been range-bound as well, trapped between 1,022 and 1,117.

The market clearly has been seesawing as alternating concerns between a double-dip recession have emerged, cooled, resurfaced and eased again based on the most recent data point. When a longer, broader view is taken, it would seem that the "good news" is not all that good but simply not as bad as what might have been.

As I mentioned above, I expect there to be more than a fair amount of bluster during the campaign season and, as always, we need to understand the data for ourselves. It seems to me that a fair number of institutional investors have been sitting on the sidelines and waiting to see what direction the economy and the midterm elections will take.

In reviewing economic data released over the past few weeks, some of which were slightly better than expected and some of which were far weaker than expected, it's little surprise that the Federal Reserve's Beige Book report released earlier this week showed slower growth spreading to more regions of the U.S. While there are more than a few data points to put under the microscope, I like the Beige Book because it provides a more detailed look than some of the broader statistics, such as industrial production.

Of the 12 regions the Fed tracks, economic activity slowed or was mixed in five — New York, Philadelphia, Richmond, Va., Atlanta and Chicago — up from two — Atlanta and Chicago — in the previous report. The Fed survey also found that five regions — St. Louis, Minneapolis, Kansas City, Dallas and San Francisco — reported modest growth. And two regions — Boston and Cleveland — reported improved economic activity.

Getting a bit more granular, the survey showed home sales weakened, as did construction activity. On the jobs front, the report showed that companies continue to be cautious about hiring full-time workers and have been relying instead on temporary and contract workers to meet any increases in customer demand. As I've talked about before on this topic, the incremental cost for a contractor is far lower than that for a new full-time employee when you consider the benefits associated with that new full-time worker. Keep in mind, that discrepancy does not factor in the impact of new health care regulations.

Continuing on the jobs front, the Labor Department reported that the number of job openings rose to more than 3 million in July, up 6.2 percent from the prior month, but employers didn't hire to fill them. Instead, the number of hires declined 0.4 percent to 4.2 million.

Why?

Well, as Federal Reserve Bank of Minneapolis President Narayana Kocherlakota pointed out, more than 25 percent of U.S. unemployment is linked between the mismatch between workers' skills and available jobs. I think we need to see more data on this, but if this is the case, then easing financial conditions and new stimulus efforts are going to help reduce unemployment by only so much. The notion of needing to learn a new skill set or update an existing one speaks to the heart of education — tooling and retooling, which I discussed a few columns ago.

According to Federal Reserve comments, consumers remain cautious and are limiting spending to essential items while they continue to reduce their outstanding credit, as total U.S. consumer credit fell for the sixth straight month in July. Sounds good, but let's remember that our economy hinges on consumer spending.

Factoring in all this, it's not all that surprising to find that economists and analysts downgraded their growth outlook for the domestic economy for the third month in a row despite better than expected jobs and manufacturing data last week. The key reasons for the negative revisions — stubborn unemployment and continued housing market frailty — are expected to slow Europe's recovery as well.

Buckle up.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm located in the Washington, D.C., area. 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.