- Real GDP growth could accelerate at a stronger 3.5 to 4.0 percent pace in the final quarter of this year and the first half of 2011.
- A solid rebound in retail sales, combined with a narrowing in the trade gap, a surge in the leading indicators index, and a rebound in industrial output all represent favorable economic developments.
- The net result of these events, combined with the stimulus of the latest fiscal policy actions in Washington, has provided a holiday present to the equity market that should keep on giving early next year, and our consensus view is for a 10 to 15 percent rise in the S&P 500 in 2011.
The last six weeks of a year usually mark the annual ritual whereby economists and market strategists adjust their economic and market forecasts for the balance of this year and next. Interestingly, in line with our discussion in the “Changing Seasons” commentaries in November, during the last month we have seen an almost uniform round of upward revisions in forecasts for U.S. economic growth as well as the outlook for corporate sales and earnings. At this juncture, the market consensus estimate for real GDP growth this quarter and next year has been revised upward from about 2.0 percent to almost 3.0 percent. In contrast, we believe that the latest data and the stimulus actions in Washington suggest that the economic growth path in the U.S. is now accelerating to an even stronger 3.5 to 4.0 percent pace for late 2010 and the first half of 2011. This potential path for stronger domestic economic activity has and may continue to provide support to the equity market in the weeks and months immediately ahead as the stronger growth could boost earnings for the S&P 500 Index towards $100 next year.
For several months, the U.S. consumer has lived in the world of Rodney Dangerfield and gotten no respect. Many economists have incorrectly proclaimed the death of the U.S. consumer and have for some time written off consumer spending as one of the weakest links in the economy. The economic data on the consumer does not support this view. Retail sales in November rose 0.8 percent after an upward revised 1.7 percent gain in October (originally reported at +1.2 percent), representing the fifth consecutive monthly gain in retail sales, and providing evidence that real consumer spending is expanding at its strongest pace since 2001:Q4. The GAFS component, a proxy for holiday sales that consists of general merchandise, clothing, furniture, electronic, and sporting goods sales, surged 1.3 percent in November, providing further signs that it’s beginning to look a lot like Christmas (with an added boost from an earlier than usual Hanukah this year). Moreover, the November spending data may be revised upward when internet sales, one of the strongest components, are fully captured in the upcoming revisions. The net result is that real consumer spending is providing excellent underlying support to the reacceleration in domestic economic activity.
Additional support for consumer spending early next year is gaining traction with a likely improvement in real discretionary income from a decline in employee-paid payroll taxes, a rise in household net worth and a potential improvement in labor conditions Household net worth increased $1.2 trillion in the third quarter of 2010 to almost $55 trillion. This represents about a $7 trillion rebound from the trough in consumer net worth less than two years ago. Based on the strong performance of the equity market this quarter, consumer net worth should move up towards the $57 trillion area by year-end 2010. This rise in consumer net worth, combined with a drop in household liabilities and a sharp reduction in household debt service costs, may also help to explain the improvement in consumer spending.
Domestic Economic Activity - The leading economic indicators index surged 1.1 percent in November, representing the fifth consecutive monthly gain and the largest increase since March. This acceleration was broad based and should be viewed as a sign that the economic expansion is gaining momentum. Similarly, a rise in durable goods output fueled a 0.4 percent gain in industrial production in November, the eighth increase in the last nine months, while upcoming production schedules for industries such as the automobile sector point to a sharp rebuilding of depleted inventories in early 2011.
Trade - The trade deficit for October narrowed to $38.7 billion, from $44.6 billion in September, reflecting a 3.2 percent gain in exports and a 0.5 percent decline in imports. Although the drop in imports was heavily due to lower oil imports that might not be sustainable, the strength in exports was impressive and suggests that the strong economic activity in the emerging economies will help to boost GDP growth here in the U.S. On a year-over-year basis, exports of goods were up a robust 17.9 percent in October, suggesting that strong foreign demand is providing a boost to the industrial sector. Immediately ahead, the trade report provides support for our view that the net export position will provide a positive relative contribution to real GDP growth in 2010:Q4.
Employment - Despite the deceleration in the private sector employment readings for November, labor market readings released over the last several weeks point to an improvement in employment trends which, in turn, should support discretionary consumer spending activity. Weekly unemployment claims have trended lower, while a wide range of labor market readings indicators from the regional purchasing managers’ reports, consumer sentiment surveys, and manpower planning reports, as well as the government’s JOLTS data (Job Opening and Labor Turnover Survey), have provided hints of an improvement in net new hiring from the private sector. Moreover, in mid-December, a key business survey of chief executive officers provided yet another sign that companies are getting ready to add to their payrolls and that business executives are preparing their companies for a stronger domestic economy.
The Business Roundtable is an association of chief executive officers of leading U.S. corporations with $6 trillion in annual sales and nearly 12 million employees. On a quarterly basis this group releases an assessment of economic conditions compiled from a survey of its members. Historically, this survey has been correlated with future trends in the overall economy. Accordingly, we are pleased to see that the latest CEO survey for 2010:Q4 revealed a sharp increase to 101 from 86 in 2010:Q3. This represented a significant improvement from a cycle low -5 reading in 2009:Q1 and was the strongest reading in nearly five years. The upbeat assessment of economic conditions by chief executive officers included a solid 9 point projected rise in sales, a 3.5 point gain in business capital investment, and most interestingly, a 10 point projected rise in employment. The latest gain in the CEO survey is very similar to what unfolded in late 2003 when the CEO economic outlook survey rose from 21.9 points to 89.6 in 2003:Q4 and was both a concurrent and leading indicator of the reacceleration in economic activity and solid gains in the equity market.
Taxes - The tax deal reached between President Obama and members of Congress will help to provide fiscal policy support for the economy next year. Economically, the two most significant new stimulus factors in the bill are the two percentage point reduction in the 6.2 percent worker component of the social security payroll tax and the 100 percent bonus depreciation for new business equipment. The business investment tax credit should provide a significant boost to business investment, industrial output and domestic economic activity in the first half of 2011, all of which are good events for the equity market.
The tax plan carries an extremely large $858 billion price tag, and while the net result of this plan should boost near term economic activity, it will also increase the Federal budget deficit to a record $1.5 trillion in Fiscal Year 2011 and raise Treasury borrowing by $300 to $500 over the next 12 to 18 months. And other worries exist in the U.S. in the year ahead from state budget woes to higher energy costs and a continued sluggish housing market. So there is much work to do (and the challenges in Europe are a subject for another day), but as we gather with friends and family during this holiday season, there is reason for optimism. So, yes, Virginia, there is a Santa Claus.
From everyone at Commonfund, best wishes to all of our clients and friends for a wonderful holiday season and for a prosperous and Happy New Year.
------------------------------------------------------------------------------------------------------------------------------------------------
Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information.