— by George Leong, B. Comm.
Markets are holding on the assumption that the economy is on the mend. While there continue to be issues in the housing and jobs markets, I can confidently say that the investment climate is stronger at this juncture compared to where we were a year ago when the financial sector was in grave danger of collapsing, with hundreds of billions from the Obama administration. Yes, the balance sheet of many of the major banks continue to have junk assets on them that need to be dealt with, but it is not an issue now given the recovering economy.
A big piece of economic news this week was a strong Retail Sales report for August that pointed to an adjusted 2.7% increase in sales. The strong reading was well above the 0.2% decline in July and far better than the 2.0% estimate. Sales excluding autos were also better than expected. The number is encouraging as Retail Sales account for about 70% of GDP. What you want to see here is the development of a positive trend that shows consumers wanting to spend in spite of the housing and jobs concerns.
Not sure if I would go out and buy retailers, as I would want to wait and see if retail sales continue to ratchet higher over the upcoming months, including the key post-Thanksgiving shopping season. I would want to see consumers willing to spend.
The government economic stimulus is clearly working, as I recently said, but, as the funds run down, will the recovery continue? Consumers will need to spend the dollars over and over again for this to happen. In economic terns, this is referred to as the multiplier effect. The higher the subsequent spending caused by the initial dollar of spending, the better it will be for driving the economy higher. Will we get back to the days of reckless spending habits and lower savings? I say no. Consumers will likely be much more careful when spending.
The fear with the rise in spending is its impact on prices and inflation, along with the direction of interest rates. On the wholesale front, the Producer Price Index (PPI) jumped a surprising 1.7% in August, well above the 0.8% estimate. This is not what we want to see due to the fear of inflationary pressures. Rising inflation could make the Federal Reserve increase interest rates. Pundits do not view the reading as a concern for inflationary pressure given that it was impacted by the surge in energy and food costs. Excluding this, the PPI increased a moderate 0.2%, just slightly above the 0.1% estimate. Watch for the CPI, which is a better indicator of inflation.
Start to look at cyclical stocks that trade with the economy. The
DOW is a good overall play on the economy. The small-cap Russell 2000 will also trade higher as the economy strengthens due to its inclusion of small companies that tend to recover earlier than big companies.