Economic Update: August 2011

This morning I awoke to the news that a compromise has been reached in regards to the debt ceiling. I have been holding off posting my quarterly economic update since very little of it mattered with a potential default looming. With that axe no longer over our necks, it seems appropriate to see where the economy stands.

Looking at four key components of the economy – light vehicle sales, inventories, housing starts, and capital goods orders – all appears stable.

Capital goods orders are above average and on the rise. Housing starts are below average, but steady. Given the large surplus of real estate available in the market right now, this is about the best we can hope for. Manufacturing and trade inventories are down which means goods must be produced to meet demand; that is good. The biggest blemish we see is in auto sales and that is explainable. The auto industry is closely linked to manufacturing in Japan. The slowdowns and shutdowns of U.S. automobile plants as a result of the Japanese earthquake and tsunami were well covered by the media. With a shrinking supply, auto dealers felt less compelled to sell cars at bargain prices and as a result, car sales have slowed. Automobile prices have been on the rise, both in the new car and the used car markets.

The biggest factor affecting the economy right now is the consumer. Let us not forget that consumer spending makes up over 70% of our economy.

So perhaps a better measure of our economy is to look at the consumer. As a result of the economic meltdown, the average consumer has responded by increasing savings, and reducing their debt.

But holding the consumer back is a general lack of confidence. Consumers are not as pessimistic as they were before the recession, but they have not regained pre-recession confidence levels.

Unemployment is below its recent peak, but not by much. We lost nearly 9 million jobs in the economic meltdown, but not quite 25% of the loss has been recovered.

But breaking down the unemployment finds that the real problems are geographically concentrated. Perhaps not coincidentally the same regions with the worst unemployment are the same regions which are still feeling the worst of the housing bubble.

This is where, as investors, we must be disciplined. Turn off the news. Quit reading the papers. The media will rarely report good news. But the economic foundation for growth is in place. Corporate earnings per share today are nearly as high as they were before the recession.

Yet the market was 12% lower at the end of the second quarter (S&P500 closed at 1320.64 on June 30, 2011) than it was at the end of the second quarter 2007 (S&P500 closed at 1503.35 on June 29, 2007). That means stocks are cheaper today than they were before the recession but the earning power of each share is about the same. This is not a time to be selling and it may be a great time to be buying.