This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.
According to a gauge derived from data compiled by the American Association of Individual Investors (AAII), bullishness on U.S. stocks is beginning to emerge after the market’s rally in the past year.
The latest AAII Sentiment Survey reading shows optimists outweighed pessimists for the first time since January 2008, three months after the previous bull market ended. (See Chart from Bloomberg)
A disparity in sentiment In contrast to the cheery mood of the markets, the latest readings from consumers and small business owners indicate economic sentiment isn’t improving, despite signs of a factory rebound and less gloom on the labor front.
The National Federation of Independent Business said its optimism index for small business owners fell back in February to its December reading. The IBD/TIPP Economic Optimism Index dropped 3% in March, well below its average of the past year.
Meanwhile, the U.S. consumer sentiment also dipped in early March, according to the University of Michigan Consumer Sentiment Index.
‘Never seen anything like it’ This divergence has got Wall Street scratching its collective head. In a recent Market Watch article, Mr Mark Hulbert cited a Wall Street advisor as saying:
“The disparity between hope on Wall Street and malaise on Main Street continues. I have never seen anything like it.”
In short, the disparity may be summarized in one word – liquidity – which Wall Street has plenty of from government handouts, while Main Street remains strapped as a result of the bleak prospects in both the job and housing markets.
Behind the productivity and profit gain
Corporations are now seeing higher profits mainly through cost, inventory and workforce reductions. It is not a coincidence that U.S. productivity rose by an outsized 6.9% last quarter, while the cash U.S. corporations have on hand equals about one-tenth of the annualized gross domestic product (GDP) over the past twelve months – near a record high, according to an IHS analysis of Commerce Department data.
This type of “growth” is not real and entirely unsustainable, and at some point companies won’t be able to get their employees to keep producing more.
For Middle America, the stagnant housing market and the lack of positive job growth are two factors hindering a more robust reading for consumer sentiment. An analysis of these two factors will offer some clues to Wall Street as to what Main Street is concerned about regarding the economy.
Home not so sweet home
In the fourth quarter, national home prices fell 1.1% compared with the third quarter, according to Standard & Poor’s. Meanwhile, nearly one in four of all Americans with a mortgage – more than 11.3 million homeowners – are underwater.
The rising tide of foreclosures, bankruptcies and so-called “strategic defaults” where homeowners just stop paying mortgages on homes worth less than their associated liability, has become a well-recognized phenomenon.
About that unemployment rate ….
The picture in the job market does not offer much consolation either. After topping 10% in the last three months of 2009, the unemployment rate in the United States retreated to 9.7% in January, and is holding steady – slightly better than expected.
Nevertheless, according to economists an exodus of discouraged workers from the job market has kept the U.S. unemployment rate from climbing above 10%, and the actual unemployment rate is higher than reported by the official numbers.
Moreover, what is not in the headlines is that near one in five, or about 30 million, Americans are under-employed.
The BLS under-employment rate (U-6) in February – 16.8% seasonally adjusted – was among the highest rates the Bureau of Labor Statistics (BLS) has recorded since it started tracking the statistic in 1994. A recent Gallup Poll puts the figure at almost 20%.
A decade-low employment level
Even more telling is the ADP National Employment Report. The national employment level is at a decade low as indicated by data from both ADP and BLS ((See Chart from ADP). Meanwhile, the U.S. Employment to Population Ratio also dipped to 57.9% in February, its lowest level since 1984.
The old normal = 10 million new jobs
Analysts estimate returning to pre-recession employment levels and keeping up with working-age population growth will require the creation of 10 million or more jobs. Under the administration’s own estimate, the economy will create an average of just 95,000 jobs a month this year; that’s far from enough to make much of a difference in the jobless landscape.
… andbBeyond 2015
Generally it takes a two percentage point rise in the GDP above a “normal” level (about 2.5%) to drive the jobless rate down each single percentage point. Taking into consideration the current near 10% unemployment level and the GDP growth generally forecast at a slower pace of 2% to 3%, it could take five or more years for employment to get back to pre-recession 2007 levels.
Moody’s Economy.com also expects the unemployment rate to resume rising over the next few months, “peaking near 10.5% in the third quarter, ” while Standard & Poor’s said a return to the pre-recession employment rate is unlikely until 2015 at the earliest.
Housing has not bottomed yet
The housing market is yet to revive as many analysts predict a further price drop. The latest pending home sales data, a leading indicator, suggest weakness still in the housing market. According to the National Association of Realtors, the number of contracts to buy previously owned U.S. homes fell 7.6% in January.
In addition, there appear to be a growing backlog of potential foreclosures. As publicized recently in The Times, strapped consumers are paying credit-card bills before mortgages. This change of math stems primarily from falling house prices, loan-modification programs and restricted credit. In any case, U.S. households’ net worth in real estate was down by 53.3% from the end of 2006.
Optimism pinned on recovery
Right now, it seems the markets are shrugging off the sovereign debt crisis in Europe, and basing their optimism on the expectation of a sustained economic recovery. However, in the U.S., consumer spending still drives about 70% of the GDP growth. And for consumers, job and home equity gloom pretty much means a chock hold on spending, which presents a challenge to the business profit growth in the medium term.
From that perspective, it is probably premature for Bank of America Merrill Lynch to suggest “We suspect confidence will recover as we begin to see a turn in the labor market,” partly based on the surprise retail sales (minus autos) jump of 0.8% in the February blizzard.
Market exuberance and correction
Meanwhile, the AAII cautioned that the spread between bullish and bearish sentiment in its index is now at +20 percentage points, more than double the historical average of +9 percentage points. Historically, similarly wide spreads preceded the mini-corrections of August 2009 and January 2010. In both instances, the spread stayed at similar levels for a period of three weeks before the market topped and pulled back.
“The trouble, in my opinion, with corporate America today, is that everything is thought of in quarters.” ~ Henry Kravis
Source: Dian Chu, Economic Forecasts & Opinions, March 14, 2010.
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