Economic developments in the past month indicate no significant change in economic trends. The second-quarter Gross Domestic Product was revised slightly lower to 3.8% from the 4% earlier estimate from the government; however, the trend growth rate over the past 18 months remains around 2%. Looking forward, most other economic reports signal an expected growth rate averaging around 2.5% in the next few quarters.
Key Indicators Show Growth Continues, but Pace Slackens
The monthly indices for manufacturing and nonmanufacturing issued by the Institute for Supply Management fell slightly in September. Nonetheless, the levels of these two key indicators are still consistent with a moderate, but below-average growth rate in the next few quarters.
Nonmanufacturing Sector Advances But at a Sluggish Pace
The Index for the ISM nonmanufacturing "Report on Business" fell one percentage point to 54.8% in September from 55.8% in August. A rate above 50% indicates the sector is growing.
The industries reporting growth in September were healthcare and social assistance; retail trade; utilities; transportation and warehousing; public administration; and wholesale trade. Moreover, despite the credit market dislocations, the finance and insurance industry posted growth.
Industries reporting a decline in activity in September from the August levels are agriculture; forestry, fishing and hunting; arts, entertainment, and recreation; management of companies and support services; information; and professional, scientific, and technical services.
Manufacturing Sector Holds Its Own
The manufacturing sector continues to be a strong point in the economy as many manufacturing companies benefit from a lower dollar to boost exports. Net exports should continue to be a strong point in the GDP numbers.
In the second quarter, exports helped fuel growth in the manufacturing sector. Total exports galloped 7.5% compared to the stodgy 1.1% gain in the first quarter. Exports of goods increased at a rate of 6.6% in the second quarter in contrast to the sluggish 0.9% increase in exported goods in the first quarter.
That strong performance was posted prior to the September slide of the dollar, which should make U.S. exports in the third and fourth quarters even cheaper to overseas customers than they were in the second quarter. That should translate into an even stronger level of exports in the coming quarters.
The ISM manufacturing index—the PMI indicator—fell to 52% in September from 52.9% in August. A reading of above 50% for the PMI indicates that the manufacturing economy is generally growing; below 50% indicates it is generally contracting. Thus, despite the slip in the PMI, the manufacturing sector continues to expand. Moreover, the continued growth in September was spread across a broad spectrum of manufacturing sectors.
The Roaring Consumer Spending of the Past Moderates to a Healthier and More Normal Level
Consumer spending, as measured by personal consumption expenditures (PCE), has returned to a healthier, more moderate level. PCE in August rose 3.7% from the level a year earlier. That is about half the growth rate it was 2 to 3 years ago, when consumers were able to use their house as an ATM machine.
The current weak housing market has stemmed such inflated spending levels by consumers. The good news is that the current consumer spending pace is becoming more in line with income growth, which is a positive development for the long-term health of the economy.
Unemployment claims continue to be low and stable, which indicates that the job market is not weakening. As long as the job market holds up, consumers should be able to maintain current spending growth. That growth—coupled with strong export sales—should be enough to keep the economy out of a recession.
Outlook for Housing Sector Remains Dismal
The housing sector still looks dismal. Housing starts should remain at the recent low levels, and they might fall even lower over the next few months. It will be well into next year, at least, before a housing recovery can be expected.
Bond and Credit Markets Are Working Their Way Back to More Traditional Patterns
The bond and credit markets moved closer to normal in the past month, but they still are not totally back to normal. The spread between the federal funds rate and treasury bills, as well as the spread vs. the Libor, narrowed but in both cases continue to be wider than normal.
Yield spreads between various sectors of the market and treasuries have narrowed from their extreme spreads of about a month ago. This puts investment-grade corporate debt issues at reasonable spreads compared to the extremely narrow spreads of the past few years, but this sector is not selling at "distressed" levels at this time any more.
Investment-grade Issuers Are Finding Exit Ramps from the Commercial Paper Gridlock
If recent trends continue, the credit markets could be back to normal, for the most part, by early next year. The shrinkage in the commercial paper market has subsided for investment-grade credits, but the asset-backed sector of this market is still shrinking. The banking system has replaced asset-backed paper in the market. That has allowed this sector to avoid a liquidity crisis.
Hopes Recede for a Near-term Cut in the Fed Funds Rate
Bond yields remain low. The market is priced at levels that reflect expectations of further Fed rate cuts. If the Fed does not lower rates further at its Oct. 31 meeting, bond yields could move higher and the yield curve could steepen later this year.
At this point, I would not assume a series of Fed rate cuts. The Fed has signaled it still is concerned about inflation re-igniting. Those concerns arise from the weaker dollar, increasing wheat and corn prices, elevated copper prices, and a higher gold price.
Stock Market Remains Strong with Best Valuation since 1995
The stock market provides another signal that the economy is in position to skirt a recession. The stock market has recovered from most of the decline that occurred this summer.
The market's strength is supported with the best valuation in U.S. equities since 1995. If stock investors anticipated a decline in the economy and a corresponding decline in corporate profits, it is unlikely that the market would be as positive as it has been.
Despite such positive signals, some investors continue to worry that the stock market might become the next "bubble." It is important to remember that while a technical correction in the stock market is possible, the underlying fundamentals are strong, which stands in sharp contrast to the developments preceding the collapse of the housing bubble.