Is the Recession Worse Than We Thought?

By Paul Nowak ISSUE 808 | August 2009

U.S. gross domestic product (GDP) has now fallen four straight quarters, and the job market outlook remains grim. Despite that, stock indexes keep rallying, encouraged by the latest quarterly earnings reports and anticipating better days ahead. But could it be worse than we thought?

GDP Has Fallen Four Straight Quarters
The Commerce Department reported on Friday, July 31, that the U.S. economy contracted at a 1.0 percent annual rate in the second quarter. U.S. GDP, which measures total goods and services output within U.S. borders, has fallen for four straight quarters for the first time since government records started in 1947.

In the first three months of 2009, the economy took a dive, with GDP falling at a 6.4 percent pace.

So are things getting better or worse? Optimists will argue that the recent GDP data shows an improvement, citing that the most recent 1.0 percent slide in GDP is better than the first quarter’s 6.4 percent decline. But there are plenty of pessimists expecting the economy to get worse.  Some even argue that better GDP does not mean better stock market performance, despite GDP being the generally accepted measure of a country’s economic performance. To get a full perspective on how the economy is doing we need to look at a variety of measures while remaining skeptical in how these reports are created.

Is there any Hope for a Rebound?
Ben Bernanke, the Chairman of the Federal Reserve, thinks the recession may end later this year. Many analysts are also predicting the economy will start to grow again in the third quarter. Most of the growth predictions are around the 1.5 percent pace, which is slow by historical standards, but  nonetheless, would signal an end to the current downturn.

Many economists are predicting that the Obama stimulus package will have a strong impact on the second half of the year, with an even bigger boost in 2010. But even if the recession officially ends later this year, the job market, housing market and stock market could all remain weak.

The Job Market
Unemployment is at a 26-year high of 9.5 percent and is expected to keep rising. The consensus analyst forecast for the July employment report (due out on Friday, August 7) is for 9.7 percent, with a plunge in non-farm payrolls of 300,000. Although monthly job losses are expected to narrow, companies are likely to keep cutting jobs through the rest of the year. The Federal Reserve said it is expecting unemployment to top 10 percent by year-end. Don’t expect companies to start hiring again until they see a recovery that shows evidence of being sustainable.

The weak job market is having a direct impact on consumer spending, which accounts for 70 percent of the economy. Consumer spending decreased by 1.2 percent in the second quarter. But lower spending means higher savings. The American savings rate jumped to 5.2 percent in the second quarter, the highest level since 1998.

In addition to cutting jobs, businesses have also cut their spending on equipment and software by 9 percent in the second quarter. Compare that to the 36.4 percent drop in the first quarter and it looks like businesses may be recovering.

The Housing Market
The housing market led the U.S. economy into the recession and many believe it will lead us out. Home prices have fallen more than 32 percent from their 2006 peaks, but prices rose for the first time in May signaling a potential turnaround.

Despite some signs of stabilization, there are plenty of reasons to be wary of the housing market. Potential buyers are afraid prices declining further, and will hold off on purchasing decisions until they get a sense that it won’t be cheaper if they keep waiting.

Other parts of the housing market continue to be a drag on the economy. Revised government data shows that residential construction fell 21 percent during the first quarter and that builders cut their spending at a rate of 29.3 percent.

The Stock Market
The stock market had its best monthly performance since October 2002 with the Dow Jones Industrial Average  rising about 8 percent in the month of July. On August 3, the S&P 500 rallied above 1,000 for the first time since November. This has created a confusing scenario: why is the stock market rising in a weak economy?

You can think of the stock market as a forward-looking indicator driven by the outlook for corporate earnings. In July, a stream of earnings reports beat analyst estimates and led to overall stock market gains. But keep in mind that the gains were made in light of low volume, which is common in the summer months. We’ll have to wait and see whether the rally can continue when the volume comes back in August and September.

A continued stock market rally could lead to economic recovery, even if the economic fundamentals don’t immediately agree. Confidence is a key ingredient to the economy. If stock market sentiment continues to improve, it could lead to a self-fulfilling prophecy.

Positive signs coming from the manufacturing sector have offered some room for optimism. On August 3, the Institute for Supply Management reported its index rose to an 11-month high in July, while the Commerce Department reported that spending on U.S. construction projects unexpectedly rose 0.3 percent in June.

If you’d like further analysis of current market conditions and are interested in pursuing specific trading strategies, please contact one of our Lind Plus Market Strategists.

Paul Nowak is Events Manager at Lind-Waldock. He can be reached at pnowak@lind-waldock.com.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

© 2009 MF Global Ltd. All Rights Reserved.