- - Thursday, August 12, 2010


What a difference a week or so makes. July was a pretty good month for stocks and capped off a strong rally that began in mid-May. I say capped off because so far in August, the market, as measured by the Standard & Poor’s 500 index, is down 1.5 percent as I type this. The movement in recent days has been fast and furious, ignited by the growing realization that the economic recovery is losing steam. Hardly news to a regular reader of this column, but the number of concurring data points has grown over the past several days.

Consider the following:

Last week’s July employment report of 131,000 jobs lost was worse than expected.

Non-farm business productivity for the second quarter came in at an unexpected -0.9 percent. This not only marked the first decline since the fourth quarter of 2008, when productivity fell by 0.1 percent, but also was in sharp contrast to the metric for the first three months of the year, which was up 3.9 percent. As I have said many a time, perspective is key, so some context and a quick thought: Productivity growth ranged form 3 percent to 8 percent in 2009 and tends to improve toward the end of a recession. Needless to say, we’ll have to see if this is a blip or the start of a trend; the latter of the two would be far more worrisome.

New orders for manufactured goods fell in June for the second straight month as factory orders dropped by 1.2 percent, per the Commerce Department. May’s decline, originally reported at -1.4 percent, was revised downward to -1.8 percent. Factory-order declines in May and June follow nine straight months of increases that buoyed freight shipments. As with the productivity data, we will need to watch factory orders to determine if this is a pause or the start of something more.

As many were aware, the Federal Open Market Committee met this week and shared its view on the economy. The Fed acknowledged “that the pace of recovery in output and employment has slowed in recent months.” I would note that this was a very different sentiment from the June statement “that the economic recovery is proceeding and that the labor market is improving gradually.”

Cisco Systems, a bellwether for corporate IT spending as well as the overall stock market and one of the first companies that predicted the slowing economy would turn into a recession, announced quarterly results that fell short of revenue expectations. Moreover, Chief Executive John T. Chambers commented that most of Cisco’s large customers would agree with recent Federal Reserve comments that the economic recovery has been “more modest” than anticipated. Mr. Chambers went on to say that Cisco customers expect “a very gradual return to more normal economic conditions.”

More recently, the European Central Bank voiced its view that healthier banks and more private-sector demand are necessary if the economic recovery is to continue in the eurozone and on a global basis. That comment was sparked by the unexpected drop in eurozone industrial production for June.

This week’s weekly new unemployment claims of 484,000, was not only up week over week but higher than expected as well.

Take all of this together, and it becomes rather easy to see why the stock market is under pressure.

My issue is that this is but the latest data but by no means the only data to signal that the second half of 2010 is bound to be slower than the first half in terms of economic growth. Moreover, I would argue that earnings expectations for 2010 in full have yet to catch up. As I write this, the 2010 Street consensus for S&P 500 operating earnings is $79.66, up dramatically from $60.80 in 2009. The catch as it were is the expectation of continued earnings growth in the second half compared to the first.

Granted, that growth is slated to be at a much slower rate, near 5 percent, compared to the high-single-digit to low-double-digit growth delivered in recent quarters. More troubling, however, is the implied year-over-year earnings expectation for the second half of 2010 compared to the comparable period in 2009 — up 20 percent. Balance that against the above data points, and let’s just say I tend to get a tad gun-shy when expectations get high, as there tends to be ample room for disappointment. Negative revisions to those earnings expectations would lead to concern over market multiples and fan the flames over how much upside or downside there is in the overall stock market.

That is why in recent columns I have been taking a more selective stance on how to be positioned in the current stock-market environment. Hence recent commentary on ways to invest in Internet traffic growth and my cash-strapped-consumer theme. After all, not all are professional traders who can watch the tick of each stock movement and trade as needed. Besides, I prefer to be positioned more as an investor in companies for the longer term. I suspect many of you do as well.

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 [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.

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