8/18/2010
By Carlos Guillen, Semiconductor Analyst

As the midpoint of the third quarter goes by, I can see that the economic backdrop has certainly been improving, but questions still remain as to whether growth will be as high as previously expected, and some have even put the notion of a double-dip recession back on the table. GDP has sequentially improved during the last four quarters, and even looking at year-over-year GDP growth, I can see three consecutive quarters of growth. However, there is still very mixed data, some indicating a continuing recovery and others indicating a recession like economic backdrop ahead.

Taking a look at housing permits for instance, which was recently released, I can see that the housing situation may be taking a slight turn for the worse. As it can be observed in the building permits chart below, which is seen as a good indicator of future housing activity, housing permits in July decreased month-to-month by 3.09 percent to 565 thousand units. Looking at the housing starts result, while it appeared to have made a nice increase, this was only the case because of heavy revisions to June's data, and still the 546 thousand unit result was under the Street's consensus estimate of 555 thousand. In essence, the general state of housing remains weak, and there are no significant signs that this sector will improve anytime soon as inventory levels still remain high.

As far as the jobs situation is concerned, the unemployment rate in July clocked in at 9.5 percent, which remained unchanged from that of the prior month, landing apparently better than the Street's estimate of 9.6 percent. While the unemployment rate result for the month of July did not appear to get worse and while its trend appears to be slowly improving, I think that just looking at the rate itself is not telling the entire story.

To get a better measure of what has been occurring most recently, one has to look at the employment-population ratio, which is the percentage of the civilian non-institutional population that is employed. As it can be observed below, this ratio has been getting worse during the last three consecutive months. Looking forward, however, I am not that pessimistic about the job situation, and I expect the employment-population ratio to level off and begin to increase slowly as companies continue to very gently increase production.

Perhaps somewhat encouraging was the University of Michigan consumer sentiment result last week, as the index increased to 69.6 in August from the 67.8 level posted in July. This uptick came despite the continuing high unemployment rates; however, the result was slightly under the Street's consensus estimate of 70.0. While consumers have been concerned that the economy's recovery will be slow, it is also apparent that they don't believe their personal finances will be significantly affected. At the same time, consumers believe that inflation will increase by 2.8%, despite current low levels of inflation.

Taking a look at the Purchasing Managers Index (PMI, from the Institute for Supply Management), I can see that its trend is beginning worsen. PMI in July clocked in at 55.5%, representing a slight decreased from 56.2% reported in June. However, given that the reading continues to be above 50% indicates that the manufacturing sector has been generally expanding, and this has been the case for twelve consecutive months. Moreover, given that PMI was greater than 42.0% over a period of time, indicates that the overall economy has been expanding, and this has been occurring for the fifteenth consecutive month. So the result was mixed, indicating continuing economic growth, but at the same time indicating increasing risk of slowing growth in the near future.

Last month, the Conference Board announced that its index of Leading Economic Indicators (LEI) decreased by 0.2% in the time frame between May and June, landing in-line with the Street's consensus estimate of 109.8. Clearly, this index is having difficulty continuing its uptrend as it turned negative for the second time in the last three months.

Within the components that make up the LEI, we were discouraged that the average weekly initial claims for unemployment insurance and average weekly manufacturing hours were included among the five components that were negative. However, we were encouraged that consumer expectations were positive. The consumer represents approximately 70% of GDP, and it is crucial that they feel optimistic about the future so that they do not hold back on spending.

So far the prospects for U.S. GDP growth during the rest of 2010 and into 2011 are mixed. For instance, Goldman Sachs recently turned negative on GDP growth, decreasing its forecasted 2011 GDP growth rate to 1.9 percent from 2.5 percent, while maintaining its 2010 forecast intact at 2.7 percent. On the other hand, The Milken Institute expects U.S. GDP growth to exceed 3 percent, not just this year, but in 2011 and 2012 as well. While I continue to see mixed economic data, the bottom line is that there will be growth, and I continue to be optimistic about achieving normal GDP growth of about 3 percent in 2010.

Carlos Guillen
Wall Street Strategies