Farrell: I Hope This Alan is Right

Alan Blinder, former Fed governor and Princeton economist, wrote articles for both the Wall Street Journal on Friday and the New York Timeson Sunday. (I wonder if he's campaigning for something.) The Journal article was especially interesting. He said,"The US economy appears to be hitting bottom," and the second-half GDP could well be a 3% annual rate of gain or more.

He used an interesting example to illustrate how this could come to be. Housing is now 2.6% of GDP. In the first quarter of 2009, spending on new homes was off 39%. If that went to zero and not -39%, it alone would be a 1% gain in GDP (2.6% x 39% is roughly 1%). I want him to be right, but I'm not sure many of us will care about GDP if unemployment is still rising.

A recovery in the second half would likely be production-led (to replenish inventory draw-downs), not demand-led. There probably would not be much follow-through unless consumer spending were to pick up. Wages and salaries, which are 60% of income, have fallen. Total income is up due to tax cuts and federal programs. But the impact of those is momentary. My partner, Lyle Gramley, expects a modest increase in second-half GDP, but, with unemployment high and rising, capacity utilization at record lows, and income stagnant, it's hard to see much more than a modest bounce.

There is better news around the world. It has been reported many times that China's economy is growing at an 8% rate. The German IFO index, a measure of business sentiment, rose for the fourth month in a row. The European Composite Purchasing Managers Index has been up five months in a row. South Korea's GDP grew 2.5% annually last quarter, which is the fastest growth rate in five years. Our own Uncle Ben is winding down two Term Auction Facilities because they are no longer needed, and that is a clear sign the credit market is healing.

77% of companies reporting earnings have beaten estimates.

As I have been saying, though, that's not due to revenue growth, but more a result of cost-cutting and a variety of one-time items. Caterpillar, for example, reported $0.60 a share versus the $0.22 estimate but $0.31 of the beat came from an abnormally low tax rate (10%) and one-time currency gains.

This week sees reports on new-home sales, consumer confidence, and durable goods. The big reports will be the Case-Shiller housing index for May on Tuesday. It's likely to show an annual decline of 18%, which has been the pattern the past few months. But since the supply of existing homes for sale is now down to 9.4 months from a high of 11.8 months in April, we may soon see some relief in that statistic. GDP for the second quarter will be announced Friday, and the consensus is for a decline of 1.5%. We're guessing it might be a little bit better than that. The Feds "Beige Book" will be released Wednesday, and that always makes for interesting reading. During the week, there will be about a bazillion dollars of new Treasury debt offered for sale, which will surely test the market.

We don't follow Microsoft at Soleil but for whatever it's worth, I think the stock is worth a look. At $23.5, it trades at only 14 times the consensus estimate for this year. While it just reported a disappointing quarter, new products like the search engine Bing and the launch of Windows 7 in October, might breathe some life back into the stock. The company has $31 billion in cash, up from $24 billion a year ago. The company is a cash machine.