The Big Picture | Is an Economic Recovery Already Priced In?

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Is an Economic Recovery Already Priced In?

Monday, October 27, 2003 | 02:24 PM

More than half the companies in the S&P500 have reported earnings so far, and but for a few notable exceptions, earnings have been better than expected. This week will see about half as many earnings conference calls and by the time Friday rolls around, 82% of the S&P500 will have reported Q3 earnings, and expectations for next year.

The negative to neutral reaction to positive earnings suggests to us that the markets have nearly priced in all of the 3rd quarter’s sizzling 6% GDP. Prior to last week’s drop, Bullish sentiment had gotten extreme. That sent several technical indicators -- most notably the VIX - into the danger zone.

Away from the earnings parade, the economic news is somewhat mixed. Several data points present a muddled picture of the economy: Wages (higher), Capacity Utilization (still low), and Money Supply (formerly rising, now falling). An analysis of of each follow:

The stubborn unemployment/jobless rate continues to remain the anathema of the recovery. At this stage of the recovery, these should be dramatically improving (they’re not). The silver lining is the increase in wages paid, although total hours worked have eased. The sharp rise in productivity, combined with a desire by companies to hold onto their best employees is, in our opinion, what is most likely behind this statistical improvement.

Wage increases typically work their way into the broader economy through increased consumer spending; If this trend stays positive, we may have a surprisingly good retail holiday season. (Now if only consumers would become less reliant on debt to support their “sport shopping” habits).

A worrisome divergence of Capacity Utilization and Earnings continues to spread (see chart nearby). Low utilization rates and healthy profit increases suggests that end user demand remains somewhat anemic, which is consistent with the cost-cutting and layoff based profitability (versus top line growth) of many tech and manufacturing companies today.

Finally, we note the danger that the healthy increases we have seen in Money Supply may be tailing off. Recent data shows that the Fed’s increase in Money Supply has ceased growing at the marked rate it saw earlier this year. In recent weeks it has reversed course and has actually started to decline. This is potentially worrisome, as M2 is the fuel consumed by the market and burned during rallies. Choking off that fuel could potentially curtail the rally’s ascent.