Weaker Consumer Confidence/Sentiment A Headwind

The sentiment readings released so far this month continue to be reported at levels weaker than those associated with stronger economic growth. The IBD/TIPP Economic Optimism Index is reported near the beginning of each month. In August, the TIPP Economic Optimism Index declined by 5.6 percentage points to a historic low of 35.8 vs. 41.4 in July. The index is 8.6 points below its reading of 44.4 in December 2007 when the economy entered into its last recession. Index readings above 50 indicate optimism; below 50 indicate pessimism. The TIPP Index does a fairly decent job forecasting other sentiment reports released later in the month.

From The Blog of HORAN Capital Advisors

The TIPP Index is comprised of three components, all of which declined in August:

• The Six-Month Economic Outlook: a measure of how consumers feel about the economy’s prospects in the next six months.

• The Personal Financial Outlook: a measure of how Americans feel about their own finances in the next six months.

• Confidence in Federal Economic Policies: a proprietary IBD/TIPP measure of views on how government economic policies are working.

Of the 921 adults/households surveyed nationally this month, 29% of households say that at least one member of the household is looking for a full-time job. The economic policies to date have certainly not created jobs.

From The Blog of HORAN Capital Advisors

The consumer sentiment index released this past Friday was reported at 55.7 which was below expectations of 56, but, higher than the 54.9 reported in July. Tuesday the Conference Board releases its consumer confidence index. Consensus expectations are for the confidence report to come in at 52%. These levels are very depressed and far from an 80% reading that would be consistent with strong economic conditions. The importance of these sentiment and confidence figures is their correlation to consumer spending and more specifically retail sales.

From The Blog of HORAN Capital Advisors

Source: Barron's

Historically consumers have accounted for 70% of GDP and this deleveraging cycle is certainly influencing the consumer.

Equity Put/Call Ratio Above 1.0 Again

Once again the equity put/call ratio moved above 1.0 at the close on Friday, reaching 1.04. The equity P/C ratio tends to measure the sentiment of the individual investor by dividing put volume by call volume. At the extremes, this particular measure is a contrarian one; hence, P/C ratios above 1.0 signal overly bearish sentiment from the individual investor. This indicator's average over the last 5-years is approximately .7, indicating the individual investor has been generally mostly bullish and more active on the call volume side.

From The Blog of HORAN Capital Advisors

For the institutional investor, technical analyst generally consider the index put/call ratio as a reflection of institutional sentiment. The index P/C ratio is slightly elevated at 1.53 and above its 5-year average of 1.4; however, in August 2007, the index P/C ratio stood at 2.7. Some would consider the current level of the index P/C as neither a bearish or bullish market sign at this time.

At HORAN, we believe business fundamentals are contrasting with equity market actions. This divergence is being driven in large part by the lack of confidence in Europe in dealing with its sovereign debt issues and in Washington's inability to deal with its budget deficit. Additionally, the amount of regulatory uncertainty that includes health care reform and potential income tax reform is a factor in business' ability to commit to longer term expansion plans. All of this also weighs negatively on consumer confidence and sentiment as well.

As the below chart shows, consumer confidence remains in an uptrend since early 2009; however, since February 2011 the confidence trend has been declining.

From The Blog of HORAN Capital Advisors

Lastly, there are some positive economic data points.

• Industrial production in July was reported at .9% versus expectations of .5%. May and June industrial production were revised higher as well.
• Leading economic indicators index increased .5% versus expectations of a .2% increase.
• The Conference Board's coincident economic index (CEI) increased .3% with all four of its components increasing. Industrial production is a component of the CEI.
  

From The Blog of HORAN Capital Advisors

It is difficult to predict the markets in the short term, but technicals are starting to point to an oversold level as noted in this chart link and fundamentals, corporate and economic, are not decidedly negative. It seems to portend a slow economic growth environment with a focus on deleveraging around the globe.

Philly Fed Report Not A Good Predictor Of Future Stock Market Action

Analyst are extrapolating the weak report for the Philadelphia Fed Outlook on Thursday as a precursor to more stock market weakness. In actuality though, the monthly performance of the S&P 500 Index has a very low correlation to the monthly Philly Fed report. The below chart shows the data from August 2007 through August 2011. The "red" plot point is the August 2011 data.

From The Blog of HORAN Capital Advisors

As the above chart shows, the monthly Philly Fed report and the monthly return for the S&P 500 Index have a low correlation of .356. Additionally, the R-squared is only .127. The t-statistic is very low as well. The flatness of the best fit line is some indication that the market's performance is not very dependent on the monthly Philly Fed data.

In looking at the one year return for the S&P 500 regressed against the one month Philly Fed data does show a higher correlation, .791 and a higher R-squared of .626. If I compare the data back to 1996, the correlation and R-squared are slightly lower than that show in the below chart. Additionally, the one month S&P return versus monthly Philly Fed report has a very low correlation and low R-squared.

From The Blog of HORAN Capital Advisors

In a vacuum and in the short term then, this one Fed report is not a good predictor of future market returns. Certainly, the Fed report deserves investor attention; however, this data needs to be balanced against other fundamental company data and other economic data. We do believe the risk of a recession has risen, maybe 50-50 now versus one in three several weeks ago. Issues in Europe and lack of leadership in Washington in dealing with budget and economic issues is weighing negatively on consumer and business sentiment. This negative influence on sentiment can negatively impact future economic activity.

Certainly Short Term Oversold After Today

After today's market downdraft, the market is certainly oversold on a short term basis. The percentage of stocks trading above their 50 day moving average is now at the same level reached in late 2008, i.e., .40%. The caveat is, historically, the market has had a tendency to trade lower on a prospective basis after these low moving average percentage levels are reached.

From The Blog of HORAN Capital Advisors

Additionally, for those that are superstitious, the S&P 500 Index feel 6.66% today and reached a low of 666 in March 2009. Could it be at least a short term bottom?

From The Blog of HORAN Capital Advisors

A key question will be the impact the recent market action has on consumer and business sentiment. Additionally, if Congress and the administration in Washington would simply stop pointing fingers at S&P and admit and address the budget problem, i.e., reduce federal expenses, the market could find firmer footing. Now the increased risk is the negative impact on sentiment and is the potential impact on sentiment enough to tip the economy into a recession. Lastly, Europe has problems that could ripple through the global economy as well.

U.S. Government Spending Versus Revenue As % Of GDP

As S&P noted in their downgrade of the U.S. government's credit rating, the rate of growth in the U.S.'s spending is a significant reason for the downgrade.

From The Blog of HORAN Capital Advisors

Government Regulations Fueling Business Uncertainty

Talk to any owner of a business and they will tell you one of the major issues that inhibits the company's ability to grow is not only the level of regulations, but the proliferation of ongoing new regulations.

A recent report by the Heritage Foundation notes,

• The spring 2011 Unified Agenda (also known as the Semiannual Regulatory Agenda) lists 2,785 rules (proposed and final) in the pipeline (emphasis added).

• Of those, 144 were classified as “economically significant.” With each of the 144 pending major rules expected to cost at least $100 million annually, they represent at least $14 billion in new burdens each year.
  

From The Blog of HORAN Capital Advisors

Another negative impact of increased regulations is it swells the growth of government.

• ...regulatory staff at federal agencies (full-time equivalents) increased about 3 percent between 2009 and 2010, from 262,241 to 271,235, and is estimated to rise another 4 percent—to 281,832—in 2011.

• Federal outlays for developing and enforcing regulations are also expected to grow by 4 percent this year, from $46.9 billion in 2010 (in constant 2005 dollars) to $48.9 billion.

Reducing the regulatory burden would be one way Congress and the administration in Washington could relieve some of the uncertainty facing companies in the private sector. Additionally, reducing the growth of regulations would stem the growth of government.

Source:

Red Tape Rising: A 2011 Mid-Year Report
The Heritage Foundation
By: James Gattuso and Diane Katz
July 25, 2011
http://www.heritage.org/research/reports/2011/07/red-tape-rising-a-2011-mid-year-report

U.S. Credit Rating Downgraded From AAA to AA+

For the first time in history, the U.S.'s credit rating was lowered by Standard & Poor's from AAA to AA+. S&P’s action is the most tangible vote of disapproval so far by Wall Street on the deal between President Obama and Congress to cut the deficit by at least $2.1 trillion over 10 years. S&P has said that it wanted at least $4 trillion of deficit reduction. S&P noted the recent debt ceiling hike did not adequately deal with the underlining deficit issues. The federal budget is at a point where Congress and the administration must deal with the growth in the budget's long term annual deficits.

The full S&P downgrade report can be read here.

Uncertainty: A Correction But Not 2008/2009

This morning we sent out a client note covering the recent market action in light of the market's volatility. Much of the recent discussion has centered around the U.S. economy falling into a “double dip” recession. A recent JP Morgan strategy comment to investors noted the following:

“Historically, US recessions were about over expansion (consumer or business) followed by a contraction of liquidity-businesses/consumers have strong balance sheets and while the US bank system is extremely well capitalized today, it is hard to imagine the right impulse exists to create a recession.”

Our market comment titled, Uncertainty: A Correction but not 2008/2009, can be read by clicking the comment title link.

If we can answer any additional questions, please do not hesitate to call on us.

Market Short Term Oversold

Today's market sell off has the S&P 500 Index down for seven days in a row. The S&P index has declined 6.8% in this seven day period. A result of this decline is the number of stocks trading above their 50 day moving average has declined to 14%, a level at which the market has rebounded historically.

From The Blog of HORAN Capital Advisors

As we noted in our prior comments and second quarter newsletter, the market does seem stuck in a trading range. Today's decline puts the S&P at the bottom of the range that began in late February of this year. Additionally, the market could be in the process of making a double bottom, if not a triple one.

From The Blog of HORAN Capital Advisors

Lastly, several of the recent economic data points have come in on the weaker side. Confidence has been negatively impacted by the actions in Washington over the last several weeks; however, we believe the weaker manufacturing data points are partly related to the supply disruptions due to the tsunami in Japan. In short, we do not see a strong economic recovery from this point, but we do not see a double dip recession either. We believe the economy is stuck in a slow growth environment, which may not improve until business uncertainty is lessened.