Stock volatility overshadows, threatens economic recovery

McClatchy NewspapersMay 25, 2010 

WASHINGTON — You wouldn't know it from watching the stock market, but the U.S. economic recovery has gathered steam, with gains in employment, consumer confidence and a host of other indicators. The return of volatility in financial markets, however, threatens these gains.

There are numerous positive signals, not the least of which includes a return to hiring in most states and economic growth for three consecutive quarters.

The National Association for Business Economics, in an outlook released Monday, revised upward its prediction for economic growth and business activity. The group of 46 forecasters now expects the U.S. economy to grow 3.2 percent this year, driven by pent-up demand for goods and service, improved consumer sentiment, job growth and business investment.

"Although risks involving Europe have recently escalated, the outlook in this country has improved in most respects. Growth prospects are stronger, unemployment and inflation are lower, and worries ... have diminished," the NABE Outlook survey said.

Troubling signs remain, however, ranging from doubts about the strength of a housing-market recovery to huge state and federal deficits that could spook investors.

Stock prices historically reflect sentiment about economic conditions six months or so into the future. From that perspective, the large run-up in stock prices last year and most of 2010 so far reflected an economy on the mend.

Now, stocks seem to be pointing to a slowing recovery later this year as federal stimulus money phases out and problems abroad plus a strengthening dollar hurt U.S. exports, one of the few consistent bright spots over the past few years.

"Stock prices incorporated the turnaround, but now you are incorporating a slower track and the economic data are confirming what was in market prices for a while," said Vincent Reinhart, a researcher at the American Enterprise Institute, a free-market policy research organization.

A former top economist at the Federal Reserve, Reinhart added that "Equity prices are telling us something that won't show up for about six months, that it is going to be a modest expansion, and there are considerable risks associated with that."

Still, the wild swings in stock prices — including a 292-point dive by the Dow Jones industrial average at the start of trading Tuesday — are overshadowing what for now is a clearly improving economy.

"The best thing is you have the (business) cycle back in force. Profits are creating jobs. Jobs are creating income. Income is creating spending. ... We're back to a sustainable economic cycle," said James Paulsen, the chief investment strategist at Wells Capital Management, an investment adviser owned by Wells Fargo Bank.

Paulsen pointed to manufacturing data, both domestic and international, that are positive and improving month by month. Global trade, until the recent scare in Europe, had been picking up, and with net job growth in five of the past six months, Americans also are getting back to work and those with jobs are breathing a bit more easily. Even the hard-hit U.S. real estate sector, he said, shows signs of life.

"I think at a minimum, both residential and even commercial (real estate) have bottomed. You can argue about whether they've turned the corner back up," but a bottom appears in place, he said.

Adding to his bullish view, consumer confidence, as measured in a monthly release by the Conference Board, improved for the third consecutive month in May, along with consumer expectations about the economy.

"Consumers' apprehension about current business conditions and the job market continues to slowly dissipate. Consumers' expectations, on the other hand, have increased sharply over the past three months," Lynn Franco, the director of the group's Consumer Research Center, said in the monthly report.

Consumers' expectations for increased employment and income also rose for the third straight month.

"While the improvement in confidence is a welcome sign that the recovery may be gathering pace, we do not view confidence as a significant driver of consumer spending," cautioned John Ryding and Conrad DeQuadros, who run forecaster RDQ Economics in New York.

Consumption powers about 70 percent of U.S. economic activity, and what'll drive consumer spending, they implied in an investment note, is employment.

Over the past three months, 42 states and the District of Columbia have posted net gains in jobs. People with jobs have money to spend, and as the employment outlook brightens, consumers are likely to be freer in their spending.

Even if employment continues to pick up, however, other factors are dragging against consumption. Sinking stock prices and the mixed bag of news about home sales and prices doesn't make Americans feel wealthier.

The National Association of Realtors said Monday that existing home sales rose 7.6 percent in April, on top of a 7 percent rise in March, but those jumps came as buyers tried to qualify for a tax credit that expired April 15.

"Although the inventory levels remain above normal and much of the gain last month was seasonal, the housing price correction appears essentially over," Lawrence Yun, the chief economist for the Realtors' group, said in a report announcing the sales numbers.

On Tuesday, the Federal Housing Finance Agency released quarterly data that showed a 2.2 percent unadjusted decline in home prices during the first three months of 2010 over the final three months of 2009. The same day, the closely watched S&P/Case-Shiller Home Price Index showed quarterly price declines in 13 of 20 major markets.

"Housing demand is increasing because of an improving job market and low interest rates. Supply, however, is also increasing because of foreclosures," Patrick Newport, a housing economist for IHS Global Insight, warned in a note to investors, predicting no bottom in home prices before next year.

Also weighing on consumer sentiment is a four-week stock-market slump. The Dow closed down 22.67 points to 10,043.90 on Tuesday, just above the psychological threshold of 10,000.

While their investments and retirement plans may be losing value, American consumers are seeing their dollars go farther. Europe's problems have brought down oil prices, which have reduced gasoline prices nationwide, and inflation, as measured by the consumer price index, is subdued.

Inflation rose 2.2 percent over the past 12 months and fell a tenth of a percentage point from March to April, the first such drop in a year. Core inflation, which excludes the volatile energy and food sectors, posted a 12-month increase in April of just 0.9 percent, the smallest gain since 1966.


April retail sales data

April existing-home sales data

Federal Housing Finance Agency home price data


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