Unemployment Rate

Initial claims for state unemployment insurance benefits surprised expectations by dropping for the second consecutive week yesterday. At 623,000 for the week ending May 23, initial claims dropped 13,000 from the prior week’s upwardly revised level of 636,000. Particularly important, the four-week moving average of initial claims dropped for the third straight week, reaching 626,750. This is a decline from the peak four-week moving average of 658,750 recorded in the week ending April 4. Although the labor markets continue to be weak, the drop in initial claims in both the weekly and the four-week moving average are positive developments.

However, continuing claims in the week ending May 16 reached a record high for the 17th consecutive week at 6.788 million. Continuing claims are representative of those that are still receiving unemployment benefits. Although the weekly initial claims figures have declined, the continued rise in continuing claims is troublesome as more an more workers remain unemployed. At the end of recessions, the continuing claims figure typically moderates as workers begin finding employment. So far this data point shows no moderation.

To gain some perspective on our current unemployment rate and recession versus previous downturns, below are a couple of Bureau of Labor Statistics graphs. The first showing the acceleration in the unemployment rate (%) since the beginning of last year... (Click on graph for full size image)















...and the unemployment rate (%) from 1970 until April 2009.














As you can see we are close to the level reached in the mid 1970's recession, but still below the peak level reached in the early 1980's recession. However, we are well above both unemployment levels reached in the past 20 years. While the Federal government has the unemployment rate peaking around 10% later this year, some economics believe the number could reach as high as 12% before the recession ends. It should noted that the government stress tests for the banks were based on unemployment of 10%, so a number above 10% could have an adverse impact on US banks' capital requirements.

Best of the Web

With the long weekend upon us, let's take a break from the financial world (if just for one week) and dive right into exploring the Internet. While almost everyone uses the web to read news stories, research certain topics, and check their checking account balance, there are a whole list of sites that are useful, fun, and informative. However, we would never know of these sites unless someone told us about them. With that in mind and to hopefully make your experience on the web more interesting and enjoyable, below is a list of sites on a wide range of topics - none of which are finance related :)

http://www.tripadvisor.com/ - travel rating service by travelers


http://www.howcast.com/ - video how-to instruction manuals, some with a touch of humor


http://www.geni.com/ - a site that allows you to build and save your family tree


http://www.mapjack.com/ - a relatively new site for viewing cities, great photos


http://www.searchme.com/ - an interactive, easy to use multi-media search engine


http://www.imeem.com/ - streaming Internet radio station with thousands of songs


http://www.freerice.com/ - site that donates rice for every question answered correctly


http://www.nibbledish.com/ - site for cooks and foodies with tons of recipes


http://www.trulia.com/ - real estate site with town and neighborhood searches


http://www.pando.com/ - great way to send large files (IE photos) through the web

Enjoy the sites and enjoy the long Memorial Day weekend with family and friends!

What could an economic recovery look like?

With the release of the April Jobs report a few weeks ago, job losses were not as great as the previous months. This decrease in job losses is consistent with an array of other recent economic indicators suggesting that the recession could be getting closer to a bottom. That perception is being increasingly discussed by officials at the Fed and others in Washington, who believe the economy should move on to a positive growth track sometime during the second half of the year. If this is correct, the deepest recession in the postwar period will come to an end. The end of a recession doesn't necessarily translate to robust growth. As we possibly move closer to the end of the recession, the question to ask is “what will the recovery period look like?”

Historically, very deep recessions tend to be followed by very robust recoveries. That was the case following the three deep downturns of 1957-58, 1973-74 and 1981-82. Conversely, the mild recessions of 1990-91 and 2001-2002 were followed by relatively mild growth. Most likely the eventual recovery is probably going to resemble the mild type rather than a typical strong growth period following a deep recession.

The recessions of the 1950s, 1970s and 1980s were brought on by an inflation-fighting monetary policies by sending interest rates higher and restricting credit availability. Once the inflation threat moderated during the recession, the Fed would reverse monetary policy, lowering rates and increasing liquidity in the economy. Personal consumption would in turn increase sharply, launching the economy into a robust recovery.

In our current situation things are slightly different. Our current recession was not brought on by tight monetary policy but by an unprecedented housing meltdown and credit crisis. The housing collapse has vaporized trillions of dollars of household wealth that will take many years to rebuild. The Fed lowering interest rates and increasing liquidity, as it has done in this cycle, is a function of trying to stop the economy from falling off a cliff and providing support to the financial system. Currently, with consumers deleveraging and reducing expenditures, there is hardly any pent-up demand that could spur consumer spending into a brisk recovery coming out of this recession.

Based on our current situation, we could expect economic growth to lack the firepower typical of a reversal from a deep recession and the eventual recovery will likely turn out to be much weaker than usual, at least here in the U.S. It is possible that a recovery could be weaker than normal for longer than most expect. We should expect there will be sectors of the economy that see above average growth while many sectors experience below average growth.

How much is a trillion dollars?

If a picture is worth a thousand words, then the chart to the left is worth a trillion dollars. The chart displays each of the various programs set forth by the different branches of government in addressing our problems. Remember at some point this spending needs to be addressed.

Double click on the chart to view full-size.

Earnings Matter

Now while we understand the whole "It's declining but not as bad as it had been", we have to wonder how “less bad” has suddenly become the new black. From an economic standpoint the main thesis for an economic recovery is we are no longer falling off a cliff and investors along with consumers are no longer white knuckled from fear. This thesis is hardly a recipe for a sustainable recovery. While “less bad” is certainly better and we need to see economic conditions improve in order to put us on a path to recovery, corporate earnings are the true driver of stock valuations. A better economy should generate an improvement in corporate earnings, which in turn should result in higher stock valuations.

Corporate earnings and present value cash flows of future earnings are what typically drive markets over short and longer term time frames. Last year the S&P 500 Index dropped roughly 40% in value corresponding to a drop in corporate earnings. According to Standard and Poor’s website, actual S&P 500 operating earnings for 2007 were $82.50 and in 2008 were $49.51; a drop of 40%, not surprising. In other words, earnings matter and stocks ultimately follow earnings.

Now let’s take a look at current earnings estimates for the S&P 500 index. In January of 2009, estimates for the S&P 500 companies for 2009 were $86.00. As of April 1st, the number had fallen to $62.00 and the current reading (as of May 5th) is $56.00. While earnings estimates continue to fall, the markets have rallied. This rally is based on the expectation that the worst is behind us and earnings for this year will begin to improve by the end of the year. In order to determine a fair valuation for the S&P 500 based on estimate earnings we can use a price earnings (P/E) multiple of 15, which is close to the historical long term average. A price earnings multiple of 15 suggests a fair valuation of around 840 on the S&P 500 index; using current estimates of $56.00. If earnings estimates move back to the $62 level or roughly 10% above current estimates and 25% above last year; a fair valuation would be roughly 930 on the S&P 500 index, or about where we are today.

What we can observe from earnings estimates is that stock valuations are likely in the fair value range given current expectations, plus or minus a few percent. However, this fair valuation assumes an increase in earnings this year and that profit margins will permanently recover to some of the highest levels in history, largely driven by leverage which, for all intensive purposes, is gone. If profit margins are now lower, more revenues will likely be needed to produce higher level of earnings as companies have already reduced expenses. If revenues don’t increase to a level to offset lower profit margins, earnings estimates will be impacted.

While we work through our economic and financial issues, deleveraging is still happening around the globe and will likely continue for some time. Deleveraging will likely have a negative impact on corporate earnings as companies shed businesses, sell assets, or raise additional capital which can dilute (lower) future earnings. At the end of the day we suspect earnings still matter and will continue to drive valuations.

Market Update 5/1/09

The US stock markets have displayed strong underlying strength over the past several weeks. Both good news and bad news has been taken in stride as every short-term decline has been greeted with buyers. Although the markets remain somewhat volatile, some stability has returned in recent weeks, which in turn has brought about an increase in investor confidence.

Perceptions are changing with respect to the stability of the global financial system and the possible turnaround in the global economy. The timing of a turnaround in the global economy is at best a guess, given the multitude of uncertainties. However, credit conditions are improving, credit markets are loosening, interest rates are very low by historical standards, and credit spreads are much better, although still elevated. The recent upswing in the US markets feels like participants are buying stocks just because they are going up, not because they are convinced a turn in the economy has occurred. Whether this is true or not remains to be seen.

We expect we will have more clarity on an economic turnaround after the first significant decline (since this recent upswing began) in the market occurs. Since this financial crisis began, credit markets have dictated the direction of stocks and we believe any positive or negative development in credit will have an impact on stocks. Therefore, if credit conditions continue to improve and institutional investors are confident in the improvement and become large buyers into any stock market decline, this will be a very positive sign and should indicate an overall improvement in economic conditions. It would be at this point one would want to become much more positive about stocks and adjust allocations accordingly.

We also remain long-term positive on commodities as they remain a finite resource in a world of seemingly infinite demand. With major cuts in production over the past six months across the commodity spectrum, we believe these "hard assets" could offer the best long-term appreciation as global economic conditions improve and supplies become scarce.

S&P/Case Shiller Home Price Index

The S&P/Case-Shiller home-price index, a closely watched gauge of U.S. home prices, continued to post declines in February but the pace stopped setting new monthly records after 16 consecutive months.

In the 20-city index, no area experienced year-over-year price gains, the eleventh straight month that has happened. Further, none of the cities managed to avoid month-to-month declines for the fifth month in a row.

Phoenix, Las Vegas and San Francisco continued to lead year-over-year decliners, with drops over 30%. Cleveland posted a large month-to-month drop, as the rate of decline accelerated there. The rates of decline also accelerated in Charlotte, New York and Washington.
Dallas, Denver, Cleveland, Boston and Charlotte managed to avoid double-digit year-over-year declines, while New York moved posted a year-to-year drop over 10% for the first time.

Measuring from each market’s peak, Dallas has suffered the least, down 11.1% from its peak in June 2007; while Phoenix is down 50.8% from its peak in June of 2006. All of the 20 metro areas are in double digit declines from their peaks, with seven — Detroit, Las Vegas, Los Angeles, Miami, Phoenix, San Francisco and San Diego — in excess of 40%.

“We continue to believe that it is unlikely that we are anywhere near a bottom in nationwide home prices,” said economist Joshua Shapiro of MFR Inc. “After all, in the seven years leading up to the peak in July 2006, the national 20 city home price index jumped by 155% (126 index points). So far, this index has dropped by 31% (63 index points) in the 30 months since the peak. By our estimation, we probably have additional downside before the we reach the total decline in this cycle.”