Investing Daily

There’s an old joke in journalism that you should never let the facts get in the way of a good story. Unfortunately, there’s a kernel of truth to that statement when it comes to media coverage of the economy and the potential for a double-dip recession.

If you simply read the headlines or watch the television news, you’re probably convinced that the economy has stalled, global credit markets are frozen and the US is headed for another vicious recession. But if you care to examine the actual data, you’ll find a different story.

Case in point: The Conference Board Consumer Confidence Index fell from a level of 62.7 in May to 52.9 in June, well below the consensus estimate of 62.5. At first blush, that figure looks scary, and headlines in the mainstream media emphasized the worst. But the graph below tells a different story.

Source: Bloomberg

As you can see, the Consumer Confidence Index has moved sideways for more than a year and shows no signs of breaking out of this range. In fact, as recently as March, the index came in at 52.3.

And although a 10-point drop appears dire, bear in mind that the same index tumbled from 56.5 in January 2010 to 46.4 in February--before regaining those losses by April.

Despite what the headlines and talking heads would have you believe, a 10-point drop in consumer confidence isn’t an unusual occurrence: Consumer confidence is a volatile data series.

The disappointing June reading hardly signals the beginning of the end for the US consumer.

Bearish commentators also fixate on the June reading for the Purchasing Managers Index (PMI) for manufacturing, which came in at 56.2, down from 59.7 in May and below the consensus estimate of 59. But readings above 50 still indicate expansion in US manufacturing.

And as you can see in the graph below, the most recent numbers are above the index’s historical average of 52.1.

Source: Bloomberg

PMI has pulled back from historically stretched levels but isn’t tanking. Over the past 40 years, the PMI for manufacturing has been above 60 only 10 percent of the time, and over the past 20 years (240 months), the PMI has only been above 60 for seven months.

In reality, April’s reading of 60.4 was a rare occurrence; it’s hardly a shock that the index has pulled back. The latest reading suggests that the rate of expansion is slowing but is far from levels that would indicate contraction. 

And let’s examine exactly what a reading of 56.2 means for US economic growth.


Source: Bloomberg

This graph plots monthly PMI readings against the year-over-year change in gross domestic product (GDP). To account for the different release periods, I averaged the three monthly readings for PMI in each quarter.

Some analysts argue that this data point isn’t relevant for the US because manufacturing only makes up about 20 percent of the economy these days. This statistic is true, but the graph doesn’t lie: Patterns in PMI and the year-over-year change in GDP track one another closely, and the relationship appears intact. In fact, I’ve found that the correlation between the PMI for manufacturing and US GDP is much tighter than the one between non-manufacturing PMI and economic growth.

PMI data is particularly useful because it’s released monthly instead of quarterly, providing an early read on quarterly GDP. Many economists factor PMI heavily into their models for forecasting GDP growth.

The average PMI reading for the three months ended in June is 58.77, up from 58.17 in the three months ended in March 2010, suggesting that the year-over-year change in GDP accelerated in the second quarter.

Even if PMI weakens a bit in the third quarter, it would still imply only a slowdown in US GDP growth on a year-over-year basis--not an outright contraction. 

Here’s another reason to dig deeper into fear-mongering headlines. A month ago the prevailing argument suggested that Europe’s sovereign-debt crisis could blossom into a full-blown credit crunch and would weigh heavily on economic growth. Others worried that Europe’s emerging focus on fiscal austerity and budget cutbacks would relegate the EU to a double-dip recession.

Once again, the economic data doesn’t back up the rhetoric; the latest readings from Europe have been surprisingly positive.

Germany is the eurozone’s largest economy; trends in that nation are for more important to the EU’s economic health than what happens in peripheral economies such as Greece, Portugal and Spain. Recent data on German exports and industrial production remain robust, as does the latest reading from the eurozone’s own manufacturing PMI.

European Central Bank (ECB) president Jean-Claude Trichet was uncharacteristically upbeat in recent comments, noting the positive data coming out of Germany and emphasizing that the pessimism surrounding Europe is overdone. He also observed that the emergency bond purchase program the ECB put in place in May was already on the wane--bond purchases in the most recent week were at 4 billion euros (USD5 billion), down from 16 billion euros (USD20 billion) in the program’s first week.

Even as traders fret over US economic data, fears surrounding Europe appear to be easing. Not only has the euro has rallied from lows around USD1.18 range to a much  healthier USD1.26, but signs of strain in the interbank lending markets also are waning. Check out this graph of the TED Spread

Source: Bloomberg

The TED spread is calculated by subtracting the yield on three-month US government bonds from the three-month London Interbank Offered Rate (LIBOR). LIBOR is the interest rate that banks charge to lend money to one another; a spike in LIBOR suggests that banks are becoming more cautious and the financial system is under stress.

As I’ve written before, popular comparisons between the EU credit “crisis” and the credit contagion of 2008 were always absurdly overblown; the TED Spread reached highs of 450 basis points in autumn 2008 but never exceeded 50 basis points during the EU credit crunch.

And in recent weeks the TED Spread has declined from nearly 50 basis points to the mid-30s. Calmer global credit markets have prompted companies to return the bond markets. In May, US corporations sold just $35 billion worth of bonds; in June, issuance nearly doubled to over $69 billion.

Swings in investor sentiment and the financial news cycle are often more extreme than the change in the underlying economy and business conditions. Early in 2010, forecasters became overly optimistic about the pace of recovery and upped estimates growth and jobs creation. The recent softness is simply a matter of expectations returning to reality.

Longtime readers know that I’ve written extensively about important headwinds facing the US and other developed market economies in coming years. This list includes a cost-conscious US consumer focused on debt repayment, a long trough in US residential housing and the risk of a bond market accident due to US fiscal profligacy.

I’ve always called for a tepid recovery in which unemployment remains high for a prolonged period; growth has been weak considering the length and severity of the 2007-09 recession.

A dispassionate analysis of the data doesn’t support the conclusion that the world is headed for a double-dip recession, nor does it back up the idea that the EU’s newfound fiscal responsibility will doom the global economy. Rather, the data suggests that we’re in for a slow, grinding recovery.

Old Money

While traveling in Europe over the past two weeks, I had occasion to speak to several EU-based investors. My research reflected my surroundings; I spent a great deal of time delving into a number of European firms.

One striking characteristic about European equities is that many companies pay much higher dividends than their US counterparts. The S&P 500 yields 2.05 percent, compared to 3.5 percent for the Euronext 100 and over 4 percent for several major European indexes. As a general rule, European investors tend to focus more on income than their US counterparts.

But that’s changing: Americans are rediscovering the importance of dividends to total returns, especially in trendless and down markets. Given my forecast for slow, uneven economic growth, I expect dividends and other income to become an increasingly important component of investors’ portfolios.

This is evident from the performance of master limited partnerships (MLP) and other income-oriented groups over the past few months.

Since hitting its closing high on April 23, the S&P 500 is down around 12 percent. In the first stages of the pullback, most stocks followed the broad market lower, regardless of underlying fundamentals.

But investors have become increasingly selective since early June, and dividend-paying groups are on fire. In fact, roughly half of the energy-focused MLPs Roger Conrad and I recommend in our MLP Profits service trade higher today than they did in late April. The average stock in our model Portfolios is up over 15 percent from its recent lows. And on top of this strong performance, MLPs offer tax-advantaged yields in the range of 6 to 12 percent.

If you’re interested in learning more about high-yielding MLPs and how they can help you make money despite weakness in the broader market, click here to sign up for a free trial of MLP Profits.