U.S. stocks rallied despite an anemic economic transition to the back-half of the year (a sickly level of activity even as the Fed has implemented an unprecedented level of monetary easing) and Intel (yes, the company that offered an ebullient forecast just a few weeks back) has begun to lower those expectations.

But never mind any of that, Bernanke, while refraining from specifics, pledged to do even more; “all that we can do” in fact, to keep the recovery going.  That was enough to spark stocks as they moved from negative territory to rally to the close.  Alas, I only wish it were enough; I think even Mr. Bernanke understands their efforts will do little more to help economic activity, but it will certainly assist the government in financing insane levels of spending – for a while at least.  Did I just say the Federal Reserve is monetizing the debt?  Moving on…

Basic material shares led the rally, no surprise there on a day in which the central banks said it will employ all unconventional tools if needed.  Consumer staples was the worst-performing group.  All 10 of the major sectors did rise on the session.

Friday’s rally helped to pare the week’s losses.  The broad market lost about 0.66%; the Dow Industrial slipped 0.62%; the NASDAQ fell 1.20%. 

Market Activity for August 27, 2010

First Revision to Q2 GDP

The Commerce Department reported that second quarter economic growth was revised down to a real annual rate of 1.6% -- it was initially estimated to have grown 2.4% via last month’s release.   This was better than expected though as expectations had the revision down to 1.4%.

The primary drivers of the downward revision were trade and inventories.  Trade (exports-imports) weighed on the reading by a full 3.37 percentage points – it was initially estimated to have subtracted 2.78 percentage points from the figure last month.  Inventories were revised down to show the segment added just 0.63 percentage point to GDP – initially estimated to have contributed 1.05 percentage points. 

There were other revisions too, as personal consumption (the largest component of GDP) grew 2.0% at an annual rate (adding 1.38 percentage points) – originally it was estimated to have increased at an annual rate of 1.6%, or adding 1.15 percentage points.  Business spending on equipment and software was also revised higher to show growth of 24.9% (again, at an annual rate) – originally the segment was expected to have increased 21.9%.  As a result, it added 1.53 percentage points to GDP rather than the 1.36 initially estimated.

Bottom line:  The economy is transitioning to the back-half of the year with no momentum.  The inventory cycle appears to have peaked out and the government stimulus is on the wane – neither of these things could have provided a durable expansion anyway.  For the inventory cycle to keep running it needs final demand, which remains very weak, and the type of stimulus the government chose to implement could only artificially boost activity – we’ll see where things go now that it has pretty much run its course, and with increased deficits to boot.  Undoubtely, all of the spending that has aggravated the fiscal deficit situation is actually hurting growth as businesses know what eventually follows such a spending romp.

And quickly on that final demand comment, real final sales were revised down to 1.0% from an already anemic 1.3% - this is GDP minus inventories.  As we’ve talked about before, this segment usually hits 4-5% in early-stage recovery. 

A final note on personal consumption: The BEA seems to be having a tough time gauging personal spending.  They’ve revised this latest number up and downwardly revised previous quarters in a big way via the annual revisions we received last month.  I suppose we’ll see an upward revision to June personal spending via today’s July personal spending report, otherwise they’ll be revising GDP down some more in the third revision, which we’ll receive next month. 

I’ve been anticipating a double dip (a quick return to negative GDP after just a few quarters of improvement), but of course we need to surpass the prior peak first in order to use this term as that’s what it takes to call this an expansion.  We’ll need roughly a 1.5% reading on third-quarter GDP to get us back to that peak, which is looking like a bit of a challenge with the data we’ve received lately.  If real GDP fails to hit that mark, then it means we never completely emerged from the recession to begin with – which may explain why the NBER (the official arbiter of the calling the business cycle) has yet to say the recession officially ended. 

University of Michigan Confidence

The UofM’s gauge of consumer confidence remained at a sub-70 reading (recessionary level) as the final print for August came in at 68.9 – UofM issues a preliminary and a final reading for each month, the preliminary reading was 69.6.

While the final reading improved slightly from July (67.8), the chart below tells the story of a depressed consumer psyche. 

Bernanke’s Speech

On the economic outlook:

Bernanke didn’t provide a concrete forecast via numbers, but did acknowledge that activity is weaker than the Fed had expected.  Still, he believes that growth in 2011 will be stronger than 2010, which isn’t saying much since we’re on pace for just 2.0% growth for all of 2010 – and that’s assuming no negative print by Q4.  Nevertheless, I think we’ll be very lucky to match this level in 2011, unfortunately.

On another round of quantitative easing:

Bernanke reiterated the generic options that he explained to Congress last month: additional purchases of securities, modifying the Committees communication, and reducing interest on excess reserves (as if the 0.25% isn’t incentive enough to lend these funds out – besides there’s a demand for loans problem that the Fed has little if any control over).  Oh, and they also added one more: raising the inflation target. 

But he didn’t even come close to providing specifics, which is what we expected.  I am surprised though that the market didn’t sell off as it appeared traders wanted to hear some clarity.  I guess the comment “the FOMC will do all it can to ensure continuation of the economy recovery” was enough. 

The strangest part of his speech was his statement that the transition from fiscal stimulus and inventory re-stocking to consumer spending and business investment “appears to be underway.”  Certainly business spending has jumped from record lows hit in 2009 and consumer spending was juiced by tax credits, transfer payments, and don’t forget borrowers allowed to remain in their homes even though their mortgages were 90, 180 even 360 days+ late (and even still household spending has ranged only 1-2%, much below the normal early expansion levels of 4-5% but such is the reality of a debt-led recession).

We’ll see over the coming months that consumer spending doesn’t have the juice and businesses will curtail equipment and software purchases as the data continues to weaken. 

Economic Cycle Research Institute’s WLI

The ECRI’s Weekly Leading Indicators came in at -9.9 after -10.1 in the prior week – meaning the measure fell at a 9.9% annualize rate. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900