Most of the pundits had expected a relief rally in stocks following a resolution to the debt ceiling crisis.
That did not happen.
Despite a last-minute agreement by Congress on Sunday night, which averted default and possibly a ratings downgrade as well, stocks fell sharply over the first two days of the week. As I write, the S&P 500 is down over 4% since Friday's close, and the index is now down for the year. So what gives? Why is the market behaving so poorly despite the hard-fought compromise by lawmakers?
The answer lies in the economic data. Over the past week we have received data point after data point that suggest the economy is inching dangerously close to recessionary territory. While most economists still believe we will avoid another recession, these same economists also agree that such weak economic growth leaves us much too susceptible to an unforeseen negative shock to the economy. This shock could come in the form of anything from a slowdown in China to a terrorist attack anywhere in the world to another flair up in the Middle East (causing oil prices to spike).
So let's review the new data we have received over the course of the past week.
- GDP grew just 1.3% in the 2Q compared to the consensus estimate of 1.8%; GDP growth for the 1Q was revised downward to a paltry 0.4% from the first estimate of 1.9%
- Consumer spending, which makes up 70% of GDP, grew just 0.1% in the 2Q compared to the consensus estimate of 0.8% and the worst reading since the second quarter of 2009
- The University of Michigan Survey of Consumer Confidence fell sharply to 63.7 in July from 71.5 in June; this was the lowest reading since March, 2009
- The ISM Manufacturing index fell sharply to 50.9 in July from 55.3 in June; this was the lowest reading since July, 2009
- Personal Spending declined 0.2% in June compared to the consensus estimate for a 0.1% increase; this was the first decline since September, 2009
- Personal Income rose just 0.1% in June compared to the consensus estimate for a 0.2% increase; this was the slowest pace of growth in 7 months
- The consumer savings rate increased to 5.4% from 5.0% and the highest level in nearly a year (While an increase in savings is good for the long-term health of the consumer, it is bad for the near-term growth of the economy)
- Gold has soared over 25% since late January and over 12% since the beginning of July; a flight to gold suggests investors are seeking a safe haven
- Housing prices continue to slide, and the 2 million+ backlog of foreclosures suggest the drops could continue
- Yield spreads on Spanish and Italian bonds have surged to new highs
- And perhaps most importantly of all, the yield on the 10-year Treasury note has fallen to 2.62%. The bond market is clearly telling us that the economy is in trouble
Looking ahead, Friday's jobs report will be the next very important piece to the economic puzzle. This morning's ADP estimate (+114K jobs in July) may have provided some comfort to those worried about Friday's government report. But while 114K jobs is nothing to sneeze at, that level of job growth is still not enough to keep up with the projected growth in the labor force and bring down the unemployment rate. In any case, another report from Challenger, Gray and Christmas this morning said that employers announced the largest number of job cuts in July in 16 months. Companies in a wide variety of industries have announced job cuts recently. These companies include Merck (up to 13K), Goldman Sachs (1K), UBS (5K), Barclay's (3K), Border's (10.7K), HSBC (up to 30K), Cisco Systems (6.5K), Boston Scientific (up to 1.4K), Research in Motion (2K), Gannett (700) and Lockheed Martin (6.5K). State and local governments also continue to shed workers as they struggle with budget deficits.