Markets have rallied since the middle of July on better than expected economic data and 2nd quarter results. However, a closer look indicates much of the good news is coming from an inventory correction and government stimulus. There have been no positive signs signalling an end to a balance sheet recession, suggesting equity and credit markets are likely headed for a pullback as these problems become more pronounced.
The world has seen the beginning of an industrial recovery. US job numbers came in better than expected, though not as good as they seem. US GDP was better than expected. Most surprisingly, Germany and France showed positive growth of .3%. Germany's exports (46.9% of GDP in 2007) increased 7%. Perhaps the most insightful data comes from the Purchasing Manager's Index (PMI). The PMI reflects purchasing manager's assessments of new orders for manufactured goods. The index is on a scale of 1 to 100, with 50 representing economic equilibrium. Anything less than 50 signifies a contraction and anything more than 50 indicates an expansion. The PMI for July showed stronger demand for manufactured goods as the index for most regions headed back to 50, approaching its January 2008 level. Also, the Fed Reserve released last Friday that industrial output increased .5% this quarter, the first increase since last October.
The growth in industrial production has led many to say the US economy is out of recession. The reasoning for this is that, historically, industrial output has been the best evidence of a recovery. There is a fundamental difference between an inventory correction and structural balance sheet deficiencies. The inventory correction is now coming to an end. However, balance sheet problems persist over a much longer period of time. It takes a while for firms to run out of cash and credit. This has been evident in past recessions, as bankruptcies and restructurings will continue even when markets have long recovered.
When one looks at the recent good news from a balance sheet perspective, the news no longer looks that good. US GDP came in better than expected but much of this came from cash-for-clunkers and other government spending. Consumer spending actually fell 1.2% annualized, twice more than expected. As wages fell an annualized 5%, it is hard to see how the consumer spending numbers will improve. (Remember consumer spending is 70% of US GDP.) Perhaps the only negative surprise in the last month has come from consumer sentiment surveys. The University of Michigan Consumer Sentiment survey came in significantly worse than expected, giving markets a quick reality check, though it didn't last long. The markets also ignored the fact that most of the "good" second quarter earnings came from drastically lower revenues, especially for retailers.
It is important to note the negative US consumer spending comes from the high amount of consumer debt. In France consumer spending actually increased 1.6%. At the same time, a forward-looking German consumer sentiment index showed positive change for August. When consumer sentiment recovers in Germany before you, you have a problem.
