Economy Continues To Weaken While Stocks Consolidate Gains

First The Good News

Stock Markets across the globe spent this past week giving back some of their recent gains.  The S&P 500 closed at 1,440 – down 20 points which works out to a 1.4% loss for the week.

September 28th was also the final day of the third quarter and it was a very good quarter for most investors.  The S&P 500 was up 5.8% in the third quarter.  The Nasdaq was up 6.9% (Thank Apple for that which has gained 64% in 2012).

Looking around the globe we see that the countries who had been down the most this year were the ones who performed the best in the third quarter.  Spain, Russia, Germany & India all recorded gains of between 10% – 14% over the past three months.

Commodities performed well in the third quarter.  Oil was up 11%.  Gold was 10% higher.  Silver went ballistic as “white lightning” posted an impressive gain of 25% over the past three months.

The S&P 500 is now higher by 15% for the year 2012.  In The Photo Section is the latest chart:

(See Image of Chart of the S&P 500 in The Photo Section)

We expect lot’s of smiles when investors open their third quarter statements and see that their brokerage accounts and 401K’s are reporting healthy gains for the year.

Historically speaking, if the Stock Markets are higher for the first nine months of the year, what has been the typical performance over the final three months of a year?   Over the past 78  years, when the S&P 500 is up 10% or more through the first 9 months of the year – 80% of the time the S&P 500 continued to go higher over the final three months of the year.

Now The Bad News

Readers of our weekly commentary at www.relianceria.com   have been reading our reporting and forecasting of the USA & Global Economy for the past few months.  We will summarize this again now (and please feel free to go to www.relianceria.com to read these articles).

• Europe is in a severe recession except for Germany.
• The Asian economies growth has slowed to their lowest levels in years.  China the driver of these economies may be close to contraction.  The Shanghai stock market is now at multi-year lows (while the S&P 500 is at multi-year highs).
• The resource based economies such as Brazil & Australia have slowed significantly as Chinese demand for industrial and agricultural commodities have fallen steeply this year.
• For the first time in many years, the USA economy and stock markets have been Outperforming the Rest of The World.
• Housing, for the first time in years, is making a positive economic impact.

The USA economy had been bucking this global trend of slowing economic  growth for much of 2012.  However, around May the first signs of slowing economic growth started to appear in the USA.  We first noticed slowing growth in the production areas of the economy.  Then we started to see more signs of economic slowing in the transportation sections of the economy.

This week, most economic reports were weaker than expected.  We would like to highlight two of these reports for our readers.

The first report  is the “Manufacturers New Orders For Durable Goods”.

New orders for durable goods (i.e. Long Lasting)  or items expected to last more than three years provide a good idea of how fast the economy is growing or slowing.

New orders for long-lasting durable goods fell 13.8% in August.  The primary cause was a big drop in orders for airplanes and autos.  Orders for computers, industrial metals and machinery also fell significantly this month.

In The Photo Section is a 10 year chart of durable goods orders.  We would like to call out to readers that this month drop in New Orders is the largest drop since the recession in 2008:

(See Image of the Chart of New Orders in The Photo Section)

The steepness of this months drop in New Orders is alarming, especially when put in context of the past 10 years.

The next Economic chart that we would like to present is called the “Chicago Fed National Activity Index” (CFNAI).  The CFNAI  is one of the more obscure economic indicators but we believe it is one of the most reliable indicators.

The CFNAI is a weighted average of 85 different economic indicators.  The CFNAI is designed to measure economic strength and weakness in the economy on a national basis.

In The Photo Section is a 15 year chart of the CFNAI.  This easy to understand CFNAI chart works this way.  When the CFNAI is above zero then the economy is growing faster than normal.  When the CFNAI is below zero then the economy is growing slower than normal.

We show the zero line with a Red Arrow on the chart.

This week the CFNAI came in at -.47 for the month of September.  This means that the economy is growing slower than normal or it’s trend average.  This was the slowest rate of economic growth since June, 2011.  It is not comforting to  see that economic growth has continued to get weaker for the past six months.

 (See Image of the Chart of the CFNAI in The Photo Section)

Evidence seems to clearly support an opinion that the US Economy has been getting weaker.  Thankfully, as we reported last week, for the first time in several years, the Housing sector is once again making a positive contribution to economic growth.  However, this growth in housing is starting from very low levels.

The constructive tone of the housing market and the multi-year highs in the stock markets have countered the weakening economic performance of the manufacturing and services  sectors and has help to push consumer confidence to multi-year highs.  However, please remember that consumer confidence tends to be a lagging indicator – not a leading indicator such as the charts above are.

Forecast For The Next Week

In general, the stock markets continue to remain overbought.  Some of this overbought condition was worked off this week with the 1.4% decline but the markets have come a long way since their June 2nd lows so it will take longer for the markets to digest their gains.

As we noted above, history shows that when the USA markets are up 10% for the first nine months of the year – 80% of the time the final three months also record a gain.  That is a very powerful historical precedent and good betting odds when you can get them.

We continue to recommend that investors to wait on putting fresh money in large amounts to work at this moment and give the markets an opportunity to consolidate their recent gains.

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John Patrick Bray, CPA, is president of Bellevue-based Reliance Investment Management LLC .

This communication reflects the opinions of Reliance Investment Management LLC and is being provided for informational purposes only and is not intended as a recommendation, an offer or solicitation for the purchase or sale of any security referenced herein or investment advice. It is being provided to you on the condition that it will not form the primary basis for any investment decision.  We recommend that you consult with your investment advisor before the purchase or sale of any securities. The information contained herein is of the date referenced and Reliance Investment Management LLC does not undertake an obligation to update such information. Reliance Investment Management LLC has obtained all market prices, data and other information from sources believed to be reliable although its accuracy or completeness cannot be guaranteed. Such information is subject to change without notice. The securities mentioned herein may not be suitable for all investors.