Economic & Market Update: June 22, 2009

“Is the Economic Glass Half Full…or Half Empty?”

The Fortigent Investment Research Team

http://www.Fortigent.com

Last Week’s Highlights:

Housing Starts:                    532K – large increase led by multi-family units

PPI:                                       0.2% – slight increase predicated by rise in gas prices

CPI:                                        0.1% – worries about inflation/deflation not materializing

Leading Indicators:              1.2% – broad support from numerous underlying indicators

Stocks:                                      921 – slightly down as investors took profits

10-year T Bonds:                3.79% – market reacts to new regs & signs of recovery

Oil:                                       $69.55 – price drops below $70 as gasoline supplies jump

Dollar/Euro:                          $1.39 – investor appetite for non-US risk assets increases

Economics This Week:

Date      Item                                                Est.                     Comment

6/23      Existing Homes Sales:     4.83M          Distressed sales continue to accelerate

6/24      Durable Orders:                  -0.9%          Appears to be approaching stability

6/24      New Home Sales:                 360K          Supply of unsold homes in decline

6/25      Final Q1 GDP:                        -5.7%         Third revision not likely to change

6/26      Personal Spending:              0.4%         Personal savings rate will be key

Where You Stand Depends on Where You Sit

School is out, summer is here, and the economy is … what? Depending on who you listen to, what you read, and what market statistics you think are important, you will come to very different answers to this seemingly simple question. Rarely in our careers has the lack of consensus on the state of the economy (and therefore, the markets) been so large.

Half-Empty

Coming down hard in the pessimist camp are those who believe that the glimmerings of economic recovery we have seen over the past few months are transient, fragile, and largely a function of massive fiscal and monetary stimulation rather than underlying economic strength. Market commentator John Mauldin (http://www.frontlinethoughts.com) highlights that what some are interpreting as signs of recovery are really just slight improvements from the dismal numbers of the previous months. In other words, the economy may be in “less bad” shape than over the past 9 months, but that is not the same as saying it is recovering. For support of his position he offers what he calls the “3 Amigos” – signals of general economic health.

The first is capacity utilization – the degree to which manufacturing facilities are producing their goods. 80% utilization is considered “normal” – anything below that is a sign of economic weakness. It is currently below 70%.

Source: St. Louis Federal Reserve Bank (http://research.stlouisfed.org/fred2/series/TCU)

The second “amigo” Mauldin analyzes is high yield bond credit spreads. While it is true that spreads have narrowed significantly over the past several months, Mauldin argues that we have simply “improved” from Armageddon to merely recessionary.

Source: John Mauldin (http://frontlinethoughts.com/article.asp?id=mwo061909)

Finally, Mauldin looks at the Institute for Supply Management (ISM) index, which is a composite index driven by survey responses on a variety of industrial and manufacturing indicators. “Half full” analysts are encouraged by the recent improvement in this index, but we remain well below the “neutral” index level of 50% (above 50% means economic expansion, below 50% means economic recession).

Source: John Mauldin (http://frontlinethoughts.com/article.asp?id=mwo061909 )

Half-Full

Those optimists who believe we have bottomed out and are on the road to real recovery are encouraged primarily by the improvement in credit spreads across the risk spectrum (an indication that investors are more optimistic about the financial health of the issuers), by an upturn in the Leading Economic Indicators (LEI) index, and by what may be a peaking of new jobless claims (the peaking of unemployment tends to be a fairly accurate signal that economic recovery is underway).

The TED spread, which measures the difference between the Treasury curve and the LIBOR swap curve, is a good proxy of the perceived risk of the banking industry. From its astronomical spike late last year, it has now fallen to below historical levels. Investment grade and high yield corporate bond spreads have fallen in a similar manner.

Source: Bloomberg.com (http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND )

The LEI index has also shown positive movement in the past two months, though it remains in recessionary territory.

Source: The Conference Board (http://www.conference-board.org/pdf_free/economics/bci/hooded.pdf )

Finally, while total unemployment continues to rise and in several states has reached double digits (with a high of 14% in auto industry devastated Michigan), new jobless claims may have peaked – frequently a signal of an impending economic recovery.

Source: Briefing.com (http://online.wsj.com/mdc/page/2_3024-claims-18.html )

Market Implications

As with the economy, the analysis and opinions on the investment markets are all over the map. Many investors are focusing on reasonable valuations, more clarity on earnings, and the improving economic environment and are anticipating a continuation of the market rally of the past 3 months – albeit at a slower pace.

Others believe that the rally – fed primarily by unprecedented monetary and fiscal stimulation – has run its course, and are anticipating a pull-back in the face of sputtering economic recovery. Some are even suggesting a drawdown to the recent market lows of early March as investors take profits, buying demand slows down, and the impact of government intervention trails off.

In the face of such contradictory economic and market signals and opinions, caution and prudence are the recommended courses of action. We seem to be at an inflection point where the economy and markets could tip in either direction. It does not appear to be a time to be sitting on the sidelines earning zero in a money market account, but neither does it appear to be the right time to go “all in”.

The Week Ahead

• Treasury to issue $104 billion in new debt
• New initial jobless claims number will show if the positive trend continues
• Michigan Consumer Sentiment will indicate if the general population believes we are on the road to recovery or not

Quotable:         “The better part of valour is discretion; in the which better part I have saved my life.” Falstaff in Henry IV, Part I (William Shakespeare).

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