U.S. stocks ended the week flat on Friday as strong results from Chicago PMI (factory activity in that region) offset a GDP report that reminded traders the recovery is weak as revisions show the consumer has played a much smaller role that previously believed.  Not that that should be a bad thing, the previous data was bewildering, as it was tough to see how consumer activity could play such a prominent role still, even with massive government help – such is the reality of roughly 10% unemployment and necessary de-leveraging.  But short-term traders don’t like to see such things.  If not for that Chicago number, stocks probably would have taken a hit.

Oddly, well if the abnormal was not so normal these days, consumer discretionary shares led the way on Friday.  Utilities and tech shares were the worst-performing groups.

For the week, the broad market closed pretty much flat – down 0.10%.  For the month, the S&P 500 posted its best results in a year – up 6.88%.  However, this did follow a 13.6% slide in the prior two months and year-to-date we’re still down – off by 1.21%.

I noticed some statements from former Fed Chairman Greenspan over the weekend in which he mentioned that the economy may fall back into recession if home prices decline again.  I bring this up because it was just two weeks ago in which he characterized the latest bout of economic weakening as a typical mid-cycle slowdown.  I found that comment interesting, not just because I disagree with it, but because it was an acknowledgment that this recovery is extremely short-lived – the normal mid-cycle slowing comes 3-4 years into an expansion; this one is occurring just a year removed from the last negative reading on GDP.  But with the latest comment from the “maestro,” it appears he’s starting to get it.  The current and coming supply of distressed properties has to push home prices down again, and as prices go so go delinquencies, followed by deterioration in bank profits and further contraction of credit. 

Market Activity for July 30, 2010

First Look at Q2 GDP and Past Revisions

Second quarter GDP, while subject to revisions as we have yet to receive the trade and inventory data for June, came in a bit weaker-than-expected but did follow a very unusual full percentage point upward revision to the first-quarter reading.

Q2 results came in at a real annual rate of growth of 2.4% (2.5% was expected), which followed 3.7% in the first – originally estimated at 2.7%; that’s a huge upward revision and very unusual.  Late 2008-early 2009 revisions showed the contraction was deeper than previously believed and that consumer activity played much less of a role than previously expected.  Again, this revision news is very strange since we’ve received several revisions already that showed no real change before this latest look.  The recession saw real GDP contract 4.1%, by far the deepest in the postwar era.

The biggest news with regard to the first quarter revision was that the consumer didn’t propel things as much as previously believed, in fact the latest numbers show the consumer is in deep de-leveraging mode as consumer activity accounted for just 51% of first-quarter GDP and was in line with the historic average of 66% in the second quarter – previous estimates had the consumer accounting for 70%-80% of GDP.  What has pushed GDP higher, albeit slight in terms of past recoveries, was the business side -- inventory and business-equipment spending after 2009’s deep decline in these areas.

The joke of this latest look at GDP was the 28% jump in residential construction, which was fostered by the sales boost delivered by the tax credit.  Housing accounts for just 3% of GDP right now, but a 28% rally adds nearly a full percentage point.  There will be a pay the piper event in the coming quarters for this segment.

The business investment side was strong in the second quarter, up 17% at an annual rate.  This was the period in which the manufacturing gauges were posting strong growth numbers.  We’ve seen the rate of growth cool of late and that is probably signaling business investment will as well.  I still suspect significant factory activity weakness will present itself by September.

So business investment is the positive side of this report, which makes sense as they’ve cut expenses to the bone and profits are strong as a result.  And even though personal consumption was weak, the strong imports figures in Q2 gave many economists the hope that the consumer will rebound again in the back half.  Unfortunately,  they may be forgetting that the bulk of the stimulus occurred in the first half, and it was certainly short-term directed stimulus that is followed by a payback effect in subsequent quarters – that’s not just my view, there’s plenty of empirical evidence to back it up; it’s why I have that view. 

Inventories, which have been a major catalyst to growth appear to have peaked.  Government spending added nearly a full point to GDP for the quarter; that’s going away as we enter the next couple of GDP reports.  We’ll be fortunate to post 2.0% economic growth for the back-half of this year.

What is important to keep in mind is what we’ve touched on several occasions now: Coming out of the worst recessions of the postwar era, real GDP has averaged 7.75% a year following those contractions, one quarter removed.  We’re not at that timeline yet for this cycle, as this latest figure is just the fourth GDP reading since the contraction ended.  But a year from that last negative reading real GDP is up just 3.2% and it doesn’t appear that we’ll have the juice for a current-quarter GDP reading to get us to even half that 7.75% historic average bounce.  This level of growth is not enough to propel the job market to a velocity that cures the weakness of government revenues, household debt, and the housing market.  Thus is will simply take more time than is normal to ultimately get things right again. 

UofM Consumer Sentiment

The revision to the University of Michigan’s preliminary reading on July consumer sentiment fell less than expected, but the figure was still meaningfully weaker than June’s  -- just as the more accurate gauge from the Conference Board has suggested, the weak job market is making consumers more negative again.  The measure fell to a reading of 67.8 for July from 76.0 in June – high 60s is off of the worst we’ve seen but it’s still a recessionary environment level.

Chicago PMI

The Chicago Purchasing Managers Index showed that factory activity was on fire in the seventh Fed district in July.  The gauge posted a reading of 62.3 (56.0 was expected) and shows that manufacturing still has its groove on – the prior regional reports we had received for the July suggested factory activity was cooling.

This latest from the Chicago region is strong and is probably supported by auto production as segment this dominates the Chicago region. 

We’ll get ISM today (the gauge for national factory activity).  If it holds above 54.0, the market will probably respond kindly.  If not, I think traders will dismiss what Chicago is saying and worry that the strongest segment of the economy is beginning to wane.

ECRI

Deeper it goes.

Have a great day!