The data released since the August edition of the Harmonic Notes e-newsletter suggests that, like a patient recovering from an illness who suffers an alarming relapse, the global economy seems to have regained its path towards gradual recovery — at least for the moment.  Unlike last month, when the data was across-the-board sour, some data series have recently stabilized or risen.

• CONSUMER

-        Home sales were abysmal after the expiration of the homebuyers’ tax credit, consumer credit continued to decline (although this is a necessary evil and a therefore a mixed blessing) and of course unemployment remains sickeningly high.

+        Retail sales, however, came in stronger than expected, as did other measures of consumer spending. Also, the Consumer Price Index rebounded to show marginally positive month-over-month growth (not that we’re rooting for inflation, but it’s better than outright deflation.) Finally, although private payrolls were uninspiring (the US economy needs about +120K new jobs each month to keep up with population growth, so +67K isn’t up to snuff) the figure improved from July and was better than expected, and the Average Hourly Earnings rose a solid +0.3%.

• BUSINESS

-        Business productivity turned negative as costs rose during 2Q10, and the ISM Service Index fell again (although it remains marginally in expansionary territory).

+        Industrial Production and Capacity Utilization were reported better than expected, though CapU remains at a very low level.  Business inventories also grew. Importantly, the ISM Manufacturing Index unexpectedly rose well into expansionary territory.

• INTERNATIONAL TRADE

+        Exports rose and imports fell as the July trade gap narrowed significantly, reversing June’s drop.

• GENERAL

-        Second quarter GDP growth was revised further down, to 1.6%.

+        The Chicago Fed National Economic Activity Index rebounded to neutral. One of our favorite leading indicators, the ECRI Weekly Leading Indicator, has trended sideways for the last 2 months; after a precipitous decline it hasn’t deteriorated further, so we’ll consider that a positive.

FISCAL POLICY

Tax policy is an issue that has the potential to push the economy one way or the other. We’re not hard-core anti-tax advocates, but it seems obvious that an economy experiencing such a fragile recovery will have a difficult time bearing the weight of higher taxes. We’re pleased, therefore, to see some dialogue about extending the lower capital gains and dividend tax rates passed during the previous administration. Doing so isn’t a panacea to the US economic problems but a 1-2 year extension might keep a little more cash in consumers’ and businesses’ pockets that they could use toward helping the economy recover.

We’re in wait-and-see mode on the recently proposed additional stimulus measures, like road and rail infrastructure spending, extension of research tax credits and a 100% write-off of business investments.  Our constant refrain may sound like a broken record, but job creation is the key to driving the economy forward: To the extent these measures create jobs we’re in favor. However, it should be noted that the proposed infrastructure bill is only $50 billion, a drop in the bucket compared to the size of the US economy, and any legislation faces (1) an extremely contentious election season until early November, when political points are worth more than solutions, and (2) a lame duck Congress from November through early January.

NO DOUBLE-DIPPING

The more positive tone of the recently released data buttresses our assertion that a double-dip recession seems unlikely. Very importantly, the consumer has for the moment risen to the occasion by heading back to retail stores after an early summer pause, and the small (12% of GDP) but crucial manufacturing sector continues to expand. Though significant headwinds remain – surveys of truckers, retailers and homebuilders have recently weakened, and a recent CFO survey showed a sharp decline in optimism, so second half economic growth won’t be stellar – our view on the currently available data is that growth won’t be negative.

Risk remains clearly skewed to the downside, however. It may be that, like an aircraft taking off, a certain amount of velocity is required for an economy to “get lift” without stalling. That supposed level is about 2% according to ISI Group, so we need to see more growth than the revised 1.6% 2Q10 figure.  

Quarter-over-quarter GDP growth, 3Q05 – 2Q10

BLESSED ARE THE WEAK…

Recent further weakening in the US Dollar helps, since it makes US exports more attractive abroad. As the alarms predicting an imminent collapse of Eurozone have faded, the Euro has strengthened against the US$. The German economy has been an unexpected bright spot. The Yen has also strengthened against the US$, recently hitting a 15-year high.

CASH IS KING

It’s well known that corporations are holding a substantial amount of cash on their balance sheets. Interpretation of this fact is in the eye of the beholder: For those with a negative outlook, the roughly $2 trillion in liquid assets held by nonfinancial firms is seen as companies creating their own “insurance policy”, rational behavior in a highly uncertain (or deflationary) economic environment. According to ISI Group companies also about $1 trillion in unrepatriated foreign earnings of US firms.  For those with a more sanguine outlook, those balances are potential fuel for a market rally.

“FEELING” BETTER (SORT OF)

Obvious to even the unseasoned observer (although not to the economists that have been blinded to reality by theory) is that sentiment plays an enormous role in the workings of economies and markets. While consumers and businesses apparently “feel” a little better than they did when we wrote last month’s newsletter, they remain very uncertain about the long-term prognosis.