Weekly Economic and Financial Commentary

More Evidence That the Recession is Ending

Mon, Aug 3 2009, 08:16 GMT
by Wells Fargo Research Team - Wells Fargo Investments, LLC | View company's profile

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More Evidence That the Recession is Ending

Real GDP declined at a 1.0 percent annual rate and newly revised data for previous years show the recession was deeper than first reported.
Inventories declined much more than expected during the second quarter, which should set the stage for a rebound in production. Real GDP should rise solidly in the third quarter, marking the end of the recession.
Consumer Confidence fell in July and remains exceptionally low. Consumers remain concerned about job and income prospects, which will continue to weigh on spending.

The Stage is Set for the Recovery to Begin

The latest batch of economic reports bolsters the case that the recession is coming to an end and the recovery is set to begin. Real GDP declined at just a 1.0 percent annual rate during the first quarter and most of that drop was due to a $141 billion plunge in business inventories. Real final sales fell at only a 0.2 percent pace in the second quarter, compared to an average drop of a 3.9 percent during the three previous quarters. The sharp drop in inventories sets the stage for significant turnaround in real GDP. If inventories decline by an additional $76 billion in the current quarter, then the slower rate of inventory drawdown would add 2.0 percentage points to real GDP. With a starting point like that, real GDP could post an eye-popping increase.

While real GDP appears poised to pop up in the third quarter it may not be the best measure of underlying demand in the economy. We have pointed out repeatedly that the GDP figures have been distorted by the unwinding of the nation’s record trade deficit and massive drawdown in business inventories. Final demand has been much weaker than the headline GDP figures, particularly in the private sector. Final sales to domestic purchasers fell at a 1.5 percent pace in the second quarter, reflecting a 1.2 percent drop in consumer outlays and an 8.9 percent decline in business fixed investment. Residential construction plummeted at a 29.3 percent pace. Those declines were offset by a 5.6 percent pick up in government spending. Final demand in the private sector declined at a 3.1 percent pace.

While a recovery in real GDP seems all but certain in the current quarter, a sustainable economic recovery will require an improvement in final demand in the private sector. There are some encouraging signs on this front. The cash for clunkers program, where owners of older motor vehicles who meet certain income requirements can qualify for a government incentive to trade-in for a new fuel-efficient vehicle, has been more successful than expected. The program has reportedly run out of funding just one week into the program, as many dealers apparently pre- qualified buyers for the program and had a backlog of sales ready to be booked. The success of the program shows that there is some pent up demand for major purchases. Unfortunately, it is unclear how this program will be extended and how much of the current sales are merely being pulled forward a few months.

Home sales and new home construction also appear to be reviving. Sales of both new and existing homes have improved for the past three months and starts of new single-family homes have risen for four months in a row. Housing prices have also perked up, although we believe part of that improvement is due to a decline in foreclosed homes coming to the market.

We continue to believe private sector final demand will be slow to recover. The latest consumer confidence figures show consumers remain very concerned about their employment and income prospects, which will keep a tight rein on discretionary purchases. With private demand weak, any inventory led rebound in GDP will have only limited staying power.

Global Review

Gradual Improvement in Global Economy

In the United Kingdom, where struggles in the housing market rivaled similar challenges in the States, there are signs of improvement as national home prices increased for the fourth time in five months. Across the channel, Euro-zone business confidence climbed for the fourth straight month but remains at low levels.
In Asia, the recovery seems to be well underway as Japanese and South Korean industrial production both increased. The pace of recovery and run up in asset prices in China has the country’s central bank considering ways to ease back the throttle.

Slow Recovery in Europe, but Picking up Steam in Asia

The fourth increase in U.K. home prices is certainly welcome news for the battered housing sector in the United Kingdom. While house prices are now actually in positive territory on a year-to-date basis, they remain off roughly 15 percent from their high water mark set in late 2006. Mortgage financing activity is another cloud with a silver lining in U.K. residential real estate. Mortgage approvals jumped to a 14-month high of 47.6K in June. Good improvement to be sure, but past periods suggest mortgage approvals need to be north of roughly 70K to be consistent with periods of steadily rising home prices.

In the Euro-zone this week, economic developments also were reflective of an economy that is pulling itself out of recession, but there is little evidence that would suggest things will come roaring back. Business confidence posted its fourth increase in as many months. It is reassuring that confidence is up from the lows seen earlier this year, but confidence remains well-below levels seen during the last decade. Capacity utilization in the Euro-zone slipped to an all-time low of 69.5 percent. Given the recent improvements in sentiment and signs of recovering global trade, this may mark the bottom for capacity utilization. The recent slack in the system has contributed to climbing unemployment rates across Europe in recent months. Germany, the largest of the euro-zone economies, has been no exception to the challenges in labor markets. But German market watchers were relieved to see that the unemployment rate remained unchanged in July despite expectations for another increase.

In Asia, signs of recovery have been less restrained in recent weeks. Even in Japan where the export-driven economy is facing its most difficult period since the aftermath of the Second World War, there are signs of a robust turnaround. Industrial production climbed for the fourth consecutive month and is now up 16.6 percent from its cycle low in February. Real household spending in Japan picked up in June and remains positive on year-over-year basis, but the gain was less than the consensus had expected. Ongoing challenges in the Japanese labor market seem to be restraining the pace of recovery. Data released this week reflect those struggles as the jobless rate jumped to 5.4 in June.

Across the Sea of Japan, South Korean industrial production notched another month of better-than-expected improvement in the latest sign of strength for the Korean economy. This marked the sixth straight month of gains for industrial production and provides further confirmation that global trade is making a comeback. The outlook for domestic demand in South Korea is also improving as data released this week showed improvement in sentiment for both businesses as well as consumers.

We also received further evidence this week that the recovery in the Chinese economy remains in gear. The latest reading of the MNI China Business Sentiment survey rose to 57.4 in July from 56.7 last month. The pace of recovery in China is so robust that the People’s Bank of China, the country’s central bank, signaled it may soon take measures to slow the run-up in asset prices.

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Published On Mon, Aug 3 2009, 12:01 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. 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