Farrell: Signs of the Recession's End

My friend and partner of over 20 years, Charlie Crane, now labors mightily at Douglass Winthrop, an investment advisory firm. Charlie pulled apart the last quarter in his most recent missive. He noted the S&P registered its fifth consecutive monthly gain and is close to 50% above its March low. All 10 of the S&P sectors gained, and the spread between number one and number ten was remarkably narrow, with Materials (up 12%) being the best, and Energy (up 4%) the worst. It was a good month to own stocks and, says Charlie, "sector allocation was not very important."

The first seven months of 2009 tell a different story.

Only three of the S&P sectors outperformed the market, which was up about 11% — remarkable when you think of the emotional state of the financial world as recently as March. Technology was up 36%, Materials 26%, and Consumer Discretionary 17%. Those three sectors account for about 27% of the market's capitalization. As Charlie says, sectors that represent almost 75% of the market underperformed through the first seven months of the year. That is a tough market for a manager to keep up with.

What's Next?
What's Next?

Interestingly, the "good" sectors are all economically sensitive, so it appears that investors are voting that the recession will soon end (or already has) and seem to be figuring that earnings will recover.

I don't disagree, but Lyle Gramley (Soleil's Senior Economic Adviser), Greg Valliere (Soleil's Chief Policy Strategist) and I all feel that the recovery will be muted, what with consumer indebtedness so high (the consumer is about 70% of all economic activity), unemployment is still rising and wages are stagnant.

Our auto analyst, Mike Ward (Soleil/Ward Transportation) got on a conference call at the end of last week to try to parse the cash for clunkers program. $1 billion was but a drop in the bucket against the wave of demand as the program was oversubscribed in less than a week. It was supposed to last through October. As a side note, and my opinion only, the horrendous mess the government made of this $1 billion program with crashing web sites and whatever does not bode well for a $1 trillion health care program. But assuming the Senate goes along with the expanded program proposed in the House, the economic benefits could be substantial.

Inventories fell $141 billion last quarter, which shaved 83 basis points off GDP.

Auto inventory drawdown was $16 billion of the $141 billion.

Unit inventories went from 2.8 million to 2.1 million. Also, Personal Consumption Expenditures fell 1.2%, and that accounted for a decline of 88 basis points in the GDP account. Germany, a country one-third the size of the U.S., committed $5 billion to its resoundingly successful cash for clunker program. It is not hard to come up with a back-of-the-envelope analysis (the only kind I know how to do) that an expansion of our clunker program could lift GDP by a fair amount by reversing some of the inventory drawdown and encouraging some consumer spending. There are those who will say this would only pull sales forward, but that's OK with me. I see a fragile recovery, and it looks like the bang for this buck surpasses anything the $787 billion pork-laden, politically-inspired "stimulus" program has done.

The manufacturing Institute of Supply Management survey released Monday had a lot of good underlying news. The number itself, 48.9 versus the consensus of 46.5, was good even if still on the contractionary side of the fence. Such a number would be consistent with 1-1.5% GDP growth. But the new orders index, at 55.3, and exports, at 50.5, showed where this index is likely to go in the near future. Inventories were a still miserable 33.5 (although up from 30.8), but most of us feel that inventories have been/are being depleted and this number is set to turn around. This was the seventh month in a row of this index rising.

Some point to it as proof of a "V" shaped recovery on the horizon. I wouldn't go that far, but, to me, it definitely points to the end of the recession.