Data-filled Week Provides Little Clarity

The economic data released this week has been decidedly ambiguous, leading to sharp volatility in the stock and bond markets. On Monday we received Personal Income and Personal Spending numbers. While spending gains were slightly above the consensus at +0.4% and the highest since March, income gains were a tad below expectations at 0.2%. The variance in growth rates caused a decline in the savings rate from 6.2% in June to 5.9% in July. Most disconcerting to investors was the fact that after adjusting for inflation, disposable income actually fell 0.1% for the first time since January. The drop is a reflection of the struggling labor market. So while the better-than-expected spending growth is good for the economy in the near term, the lack of income growth calls into question the sustainability of spending gains. Stocks initially greeted the data in stride, but sold off sharply by the end of the day on scant trading volumes. It seemed everyone was still at the beach.

On Tuesday the data improved a bit. The Case-Shiller home price indices came in better than expected, and Consumer Confidence handily beat the consensus estimate of 50.7 with a reading of 53.5. The minutes of the recent Fed meeting were also released, and these showed some consternation among voting Board members about the need to further stimulate the economy through additional quantitative easing measures. Given the deteriorating state of the labor and housing markets, many investors have been hanging their hats on additional Fed action. The lack of consensus among the Fed therefore created some additional anxiety. The markets finished the day flat after some fairly significant intra-day volatility.

Wednesday brought even more ambiguity. The day starting poorly with a weak reading of -10K from the ADP private sector employment survey. Investors who took the news in stride were handsomely rewarded as the ISM manufacturing data came in much better than expectations at 56.3 (consensus 52.8). We also received positive data from China’s manufacturing sector which added fuel to the buying spree. Investors summarily ignored weaker-than-expected prints for Construction Spending and Vehicle Sales as the major indices surged 2.5-3.0% for the day. Productivity and Unit Labor Costs, which were largely in line with expectations, also received little attention. So despite the fact that manufacturing only accounts for about 11% of the domestic economy, the bulls had returned.

And today we are getting August same-store sales from the retailers, which are largely better than expected. We also received weekly Initial Jobless Claims and Continuing Claims. These figures, which were roughly in line with the consensus estimates, continue to suggest that the labor market is struggling. Most recently, Pending Home Sales came in at +5.2%, providing hope for those pipe-dreamers that everything will be fine for housing.

And so here we stand, with the markets oscillating between positive and negative territory as we await the granddaddy of them all: the monthly employment data. Nobody is expecting much tomorrow as the consensus estimates stand at a -100K change in Non-Farm Payrolls and a scant +42K change in Private Payrolls. The Unemployment Rate is expected to tick up slightly to 9.6% from 9.5%. Has the bad news been priced in? Will anything short of a double-dip recession lead to more buying the likes of Wednesday’s rally? Do the bulls have the upper hand?

Our conslusion is that notwithstanding our continuing concerns with the housing and labor markets, valuations are attractive for high-quality, blue-chip multinational companies. In most cases these companies offer dividend yields at or better than the 10-year Treasury yield. However, stocks offer a high probability of long-term capital appreciation whereas longer-term bonds are at risk of meaningful depreciation if and when interest rates rise. So we are buyers at these levels, but we remain buyers of quality. Relative valuations for high-quality companies have rarely been better, and we expect to be rewarded over the long term.