On September 20 the National Bureau of Economic Research officially pronounced the recession which started in December 2007 ended in June 2009. At 18 months, this means the recession was the longest in the post-WWII period. It also means we can’t have a double-dip recession but instead, the next significant economic downturn will be considered a new recession. Oh joy!
Even though the NBER says the recession ended over a year ago, it does not feel like it to many folks. Consumer confidence in September fell to the lowest level in seven months as Americans became more pessimistic about the labor market. The economy has been in no-man’s land for several months now as the after-effects of the various stimulus measures are leaving the U.S. consumer with a hangover. As expected, once the buzz of government tax credits started expiring, the housing market slowed considerably. The Federal Reserve has been priming the pump by keeping short-term interest rates at or near zero resulting in some of the lowest borrowing costs in many a generation. It’s hard to believe a 15-year fixed rate mortgage is now available at 3.75%! Even with an after-tax cost of funds close to 2.5% consumers are still reluctant to buy. The reason is uncertainty.
With an official unemployment rate of 9.6% and an unofficial rate close to 17%, those folks who do have a job are not too keen on making major purchases. What they have been doing is de-leveraging their balance sheets by paying down debt. This has resulted in a very respectable savings rate of 5.8% but unfortunately, businesses need consumers to spend, not save. Those who are saving are penalized with paltry interest rates on their fixed-income investments. And of course, those who bet against stocks after the second quarter’s drubbing got a little beer in their soup. The stock market had an outstanding 3rd quarter including the best September since 1939. Isn’t September supposed to be a bad month for stocks? This again goes to show the futility of market-timing as the stock market will typically prove the consensus wrong.
The economy as measured by GDP is still growing, albeit at a modest pace. After an impressive 5% annualized growth rate in 4Q-2009, GDP slowed to 3.7% and 1.7% respectively in the first and second quarter of this year. Initial estimates for 3rd quarter GDP are not released until late October but it is clear the economy is moving into a lower gear. Post-recession growth rates have usually been much higher.
At its September meeting the FOMC left the door open a crack for further easing by stating that “inflation is running below levels the committee believes consistent with promoting price stability over the long run”. Interpretation – the Federal Reserve is quite willing to expand its balance sheet with the purchase of U.S. Treasuries to keep rates low.
There are still some bright spots in the economy. The ISM NMI (Non Manufacturing Index) increased in September, and since service sector jobs comprise 80-90% of employment this is an encouraging sign. September auto sales jumped 28% lifting hopes for the remainder of the year. And as bad as the housing market is many believe it’s finally bouncing along a bottom. Pending home sales increased in August for the 2nd month in a row. The 800 pound gorilla is still the large inventory of foreclosed homes being held by banks, most of which are reluctant to dump them into an already soft market.
You couldn’t tell the economy was just-a muddling along by the performance of the stock market during the third quarter. Large (S&P 500) and small companies (Russell 2000) alike gained 11.29% during the period. International markets had a banner quarter with the EAFE Index up a whopping 18.01% and Emerging Markets gaining 16.48%. Investors who abandoned stocks after a disappointing second quarter lived to regret it once again. Year-to-date through the first nine months of 2010 stocks returns ranged from 3.89% (S&P 500) to 10.75% (Emerging Markets). Diversification across all asset classes is imperative if one expects to reap the rewards of the better performing groups.
Bond returns were modest compared to stocks during the third quarter. Short-term government bonds (Barclays Capital 1-3 Year Government Index) had modest total returns of 0.62%. Intermediate and long-term bong bonds fared better as interest rates fell during the period resulting in greater price gains. The Barclays Capital U.S. 5-10 Year Government/Credit Index gained 4.79% and the Barclays Capital U.S. Long Government/Credit Index was up 5.85% during the period. Year-to-date, bonds are up 2.53% (short Government bonds) to 16.69% (long government /corporate). Interest rates are currently so low it’s hard to believe there will be further significant gains in bonds. As of this writing the two, five and ten year U.S. Treasury are yielding 0.38%, 1.13% and 2.39% respectively.
The November elections will determine which party (if any) controls Congress going into 2011. Again, the one word that best describes the current mindset of investors, consumers and businesses alike is uncertainty. People are uncertain about the economy, the employment outlook and tax policy among other worries. Will Congress extend the Bush tax cuts; or will they let the cuts expire causing tax rates to rise in the midst of a slow economy? If the Republicans take control of the House and Senate will President Obama sign legislation they put in front of him? They almost certainly would not have enough votes to over-ride a veto. The market would likely respond favorably to any movement towards controlling spending, extending current tax rates and clarifying the massive health-care legislation passed earlier this year. We shall see soon enough.