General Market Comment: November 9, 2009
The market had a nice rally last week following the closing of October with the worst week it had experienced the panic lows of last March. There was the usual flow of warnings that maybe the huge market rally since those lows in March was about to end. That is unlikely. While the news on the unemployment rate reported on Friday sells more advertising it was news about the continuing surge in leading economic indicators, productivity and earnings that are the better barometers of the proximate move in the market.
The move in the weekly leading economic indicators published by the ECRI (Eco. Cycle Research Inst.) remains breathtaking. The increase over the last 6 months is in the 99.9th percentile and has only been this close once in 1983. Back then the economy was recovering from the twin recessions of the early 80’s and emerging from double digit inflation. Friends – to state the obvious – these are “leading indicators” – the sharpest rise in these indicators occurs at the beginning of economic recovery and, logically enough, the beginning of sustained bullish phases in the stock market . . . that would mean – NOW – eh?
There was additional “leading” economic and market correlative data last week. The ISM (Inst. for Supply Management) issued their monthly reports on manufacturing and non-manufacturing business activity. No surprises – both reports pointed to continuing improvement. I have chosen to focus on the new orders indicators below as they have good correlation with future job growth and earnings growth. The following chart shows the diffusion index for both manufacturing and non-manufacturing sectors have turned sharply above the threshold of “50” signifying growth.
The following chart allows you to see that the ISM employment measure also turns up following an upturn in new orders – perfectly logical.
For the doubters in the crowd I have also shown that actual reported persons employed do in fact grow following an upturn in “new orders” as reported by the ISM. While it is undeniable that there are more people out of work today than anytime since the early 80’s, the ISM data suggests the situation is on the cusp of improvement.
Here is what the folks at ISI Group, run by Ed Hyman, recently displayed about the relationship of good ISM numbers and employment. They refer to “PMI” which is stands for “purchasing managers index” and is a measure of overall activity, including the “new orders” data shown above. The “PMI” index rose to 55.7 in October for the first time since June 2007.
So friends . . . help looks to be on the way for the unemployed. And, by the way, what’s good for the unemployed is obviously good for recovery of consumer demand and corporate earnings . . . it’s that “virtuous cycle” thing –eh? Speaking of which . . . let’s consider productivity for a moment. Without growth in productivity you can’t get sustained GDP growth or earnings growth. It follows that after businesses reduce employment in response to a shock to demand such as we experienced in 2008/2009 that they wait to return to prior levels of employment until – you guessed it – new orders pick up. As orders rise and are filled by the reduced workforce productivity goes up and also profits. Here is a picture of what was reported last week on the change in output per hour per person i.e. “productivity” courtesy of Brian Westbury at First Trust.
Brian stated the following . . . “ you have to go back almost 50 years to find two straight quarters where productivity has boomed as rapidly as it has in Q2/Q3 of 2009”. A boost in productivity is always a precursor to a pick up in employment . . . and PROFITS.
Here is a nifty chart by Ed Yardeni at Yardeni & Co. that takes the ISM new orders data series I have discussed and ties it to earnings growth as illustrated by the earnings of the S&P 500. Ed combines the new orders data with the “prices” index also included in the ISM data. It measures not just prices paid but is a barometer of prices received. You don’t need to be a “quant” to see that new orders and prices lead earnings. If new orders and prices are rising earnings are going to follow.
Despite recently voiced concerns about the sustainability of the market rally and the surge in corporate earnings the data suggest we are entering a sweet spot in the economic recovery where earnings growth is strongest, most widely distributed and – interestingly – the least anticipated or reflected in Street estimates and management guidance. With 88% of the S&P 500 companies already reported, 80% of the companies have beaten estimates. This compares to the next highest percentage of companies beating estimates of 73% that occurred in Q2 09.
As always, you are welcome to disagree with any or all of the above sentiments. The facts as I continue to see them still persuade me the market has more upside than downside. Pullbacks in stocks where you have a competitive knowledge advantage should be exploited.