Ramblings of a Portfolio Manager

Double Dip Talk Again?

How fickle the equity markets can be. One to two data points and the markets can change their tone on a dime. Case in point—not so long ago as mid-April many economists were talking hyper inflation, large interest rate hikes and a soaring dollar. Several weak data points later, including Friday’s miserable jobs report, and Treasury yields are back at nearly an all time low, the Euro is closing back in on $1.49 and those same pundits are now exploring a double dip recessionary scenario. The equity markets, of course, have followed in sync. With little political will for a QE3 so far, one must ask did we hit a soft patch or is the economy in Q1 or is the economy just in the process of transforming itself from stimulus-based growth to a self-sustaining engine? Just a reminder: economies NEVER move in a straight line.

A few encouraging points were missed last week. The Non-Manufacturing ISM, released on Friday as well, is still in expansion mode. Over the last 12 months the ISM non-manufacturing index has averaged 55.4 and May came in at 54.6 suggesting that this sector of the economy is still on track for an expansion. Continued gains here suggest continued gains in core retail sales and therefore consumer spending and the economy. That would mean no double-dip although it hardly suggests an accelerating economy. A few takeaways from the Non-Manufacturing ISM: Overall business activity rose in 14 industries, including real estate (interesting), construction, finance & insurance, healthcare and information. That these gains are so broad is reassuring as is the overall size of the gains. Orders were up in May with gains in 15 Industries and new orders came in at 56.8 in May compared to 52.7 in April. Among the 15 industries signaling growth were professional services, transportation, finance & insurance, healthcare and information. Since the current recover began, these sectors have exhibited job gains and an expansion in their sales. The current outlook of the US. Economy is for continued growth in these service sectors as the share of total consumer spending on services continues to grow over time. Another take away is that export orders grew in sectors such as art, entertainment & recreation, professional services, accommodation and
food services—all sectors where a strong, historical orientation to consumer service provides American suppliers with a comparative advantage.

Another oft talked about but seemingly ignored fact is prices paid, a measure of costs to the consumer. The ISM showed that prices paid increased in May again, but the index dropped to 69.6 from 70.1 in April. Seventeen industries reported an increase in prices paid, including real estate (a positive sign), accommodation & food (certainly no surprise), healthcare and professional services. Now, this may be a double-edged sword as rising prices paid suggest that many firms are getting squeezed at the bottom line in the short term and many retailers proved that it is likely that companies are having difficulty passing on input costs to their final customers given the problems faced by many consumers. However, though many commodities are up in price for non-manufacturing companies including airfares, copper, cotton, diesel fuel, gasoline and many oil derivative products these prices are expected to come down, particularly if our Chinese and Indian trading partners are successful in engineering soft landings in their respective economies (some economists are coming around to the view that these two countries are nearing the end of their tightening.. The market’s obvious fear, in the short term, is that these rising prices will crimp margins and thus earnings. However, we just came through earnings seasons for most industrial companies affected by rising input costs (retailers are still reporting) and few, if any industries, complained about their inability to pass on higher prices. True, retailers had difficulties but with a record cotton crop going into the ground the spring, that issue may also be alleviated in the fall. Gasoline is falling, which also benefits the consumer.

Of course, the Non Manufacturing ISM is but one data point but are not the markets reacting to every headline these days. Also overlooked is the fact that Greece finally, actually, really may have a resolution to their issues. That would put further downward pressure on the dollar, benefiting our exporters. Now, no country every devalued its way to prosperity, however, in the short-term, a continued weak dollar should help our exporters, bolster commodity prices and support the US markets. None of this suggests a double dip is on the horizon. And, while hope is never a good investment philosophy, there is little doubt that the Obama administration is running scared with the upcoming Presidential elections (anyone see him blame China and Europe for our woes last week? Incredible). So don’t discount some last ditch effort to create jobs (an effort that would have to begin soon to produce the desired effect by election time) as well as pressure for the Fed to keep all that liquidity in the markets for much longer than expected. So while QE3 remains off the table, liquidity will remain high and the recent sell-off on its demise seems quite overdone.