Posted by Joseph Y. Calhoun, III

It is said that stock markets discount the future so last week’s drubbing in the stock market probably has little to do with the economic statistics released last week since by definition they were reports of what has already transpired. Indeed looking through the various reports reveals an economy seemingly still in recovery mode although the pace of recovery may be slowing just a bit. The data certainly wasn’t disturbing enough to justify the nasty selloff in risk assets.

The Empire State Manufacturing Survey for May did show a slowing from April but slowing doesn’t mean slow. There is still significant evidence of increasing activity if at a slightly slower pace than last month. The new orders component fell from April’s scorching 29.5 to 14.3 but still shows signficant month to month growth in orders. The hiring component was higher from April although it should be noted that backlogs fell so hiring may stall as production catches up with sales. Overall, the report still shows signficant month to month acceleration.

Housing starts surged in April ahead of the expiration of the home buyer’s tax credit, but in a sign that builders expect a slowdown after expiration, permits fell. Starts are now running at 672K annual pace which is signifcantly higher than last year. I still expect starts to get back to the long term average of about 1.4 million over the next few years. It won’t be a straight line getting back there but unless it’s different this time and we stop forming new households, housing will continue to recover.

Producer prices fell month over month by 0.1% but the year over year change was 5.4% which isn’t exactly insignificant. The fall was led by a decline in energy prices which seems likely to repeat next month. So we might see a fall in the official inflation rate in the near term but I would not base any long term investment decisions on outright deflation as long as the Federal Reserve has access to a printing press.

The retail sales reports from Goldman and Redbook were a bit contradictory with Goldman showing a week to week drop of 2.5% (which they blamed on cold weather; really?) but the Redbook version showing a week to week gain of 0.7%. Well, actually the Redbook report doesn’t show week to week numbers, that is an extrapolation. Strangely, the year over year numbers were exactly the same at +2.9% which would seem to indicate there was some difference in this week last year as well. I don’t know what to attribute the differences to so for now I think we have to call this an outlier in the retail data until proven to be something more sustainable. The bottom line is that Americans are still shopping at a higher pace of sales than they were last year. Whether that is good or bad for the long term health of the economy depends on your point of view but for the short term it implies a certain confidence on the part of consumers.

In a foreshadowing of what happens to home sales after the tax credit expires, purchase mortgage applications fell 27.1% last week, although refinance applications rose by 14.5%. The purchase index has plunged for two straight weeks now and is back to levels last seen in 1997. Home sales, existing and new, will probably be pretty awful next month, but assuming the economy doesn’t relapse, I expect sales to pick up again in the next few months.

The consumer price index, like the wholesale, producer version, fell in April thanks to falling energy prices. Again, I do not expect outright, official, CPI deflation. The Fed has plenty of ways to make sure the price level doesn’t start falling even with rates at zero. Will we get more quantitative easing? Maybe….

In another indication that the rate of acceleration in the economy is peaking, the Leading Economic Indicators fell by 0.1% in April. Building permits, consumer confidence and jobless claims pulled the index down for the first time in more than a year. Another indication of a peak in the rate of change was the Philly Fed Survey which was similar to the Empire State survey released Monday. New orders were up but at a slower pace than last month and hiring fell as well. Inventories fell even as delivery times slowed which does bode well for future increased production but doesn’t speak well of manufacturers confidence in the recovery. I want to stress that these reports do not show weakness per se, but a slowing of the rate of increase. That is typical of economic recoveries; as the recovery matures the rates of change slow.

As has become habit around here, I’ve left the worst report for last and it is the same one that seems to end this report every week - jobless claims. There has been some relatively good news on employment recently, but new jobless claims continue to run at levels inconsistent with job growth in the past. Last week claims rose by 25000 to 471K. As I’ve said here many times, I think new claims need to fall to under 400k to get consistent job growth. The claims data seems to conflict with other more positive employment reports. The household survey, which many believe to be more accurate at turning points in the economy, is showing significant job gains over the first 4 months of the year with a net gain of nearly 300k in April alone. In addition, the regional and state employment reports are showing more strength than the national survey. Those reports showed a gain of over 300k private sector jobs in April. So why do new jobless claims remain elevated? I do not have a good explanation for how claims can remain high even as we see large increases in new jobs from some supposedly accurate sources. For now, all I can say is that the trend in jobless claims recently is at best sideways and that isn’t nearly good enough:

Risk assets of all kinds were marked down last week as investors began to question the rate of growth. Or more accurately maybe, they started to price in a double dip recession which is a low probability outcome that gets a good airing about this time in every economic recovery. As I said above, the rate of change is peaking and the more jittery in the market always seem to extrapolate that into a double dip recession. Could we get a double dip? Sure we could but it isn’t the most likely outcome; it has only happened once since the Great Depression.

Anyway, the technical damage done to markets last week was horrific and getting back into defined uptrends will not be an easy or quick task. Particularly hard hit were the commodity markets where it seems a lot of the speculative activity was centered recently. Oil over $80 really didn’t make much sense anyway and the economy will probably be better off with lower oil prices but for anyone with exposure to commodities, last week was a double whammy. Stocks got the headlines but commodities were actually the harder hit asset class. Copper, platinum or crude oil, it didn’t really matter if you suddenly found yourself worried about growth.

One thing that does need to be highlighted though is that this correction - assuming that’s all it is - only brings us back to the levels we visited in February. In fact, if the bottom from Friday holds, a technician might say that we made a higher low in the S&P; in other words a bullish development. Right now, I don’t know whether this is a correction or will turn into something more but I do expect the markets to stage a bounce here. I know investors want certainty but there simply isn’t enough evidence yet from the economy to call this anything more than a correction. Yes, there are some worrisome signs but overall, I don’t see reason to get too concerned about a garden variety 10% correction. They happen all the time and if this one seems more unnerving than past ones, that is probably becuase it comes so close to the meltdown of 2008. You can’t let your fear of a repeat of that very rare event keep you from investing with at least a little longer time frame than the close of trading.

The stock market is not particularly expensive after the correction if earnings estimates are even in the ball park. 13-15 times next years earnings is a pretty normal to cheap multiple for recent times. No it isn’t death of equities 1982 cheap and yes dividend yields are still lower than I’d like for a bear market bottom. On the other hand, dividend taxes are about to go up next year so maybe it isn’t surprising that companies aren’t rushing to increase their payouts. I don’t think much of stock buybacks, but if capital gains are taxed lower than dividends it does seem logical to spend corporate cash on buybacks rather than dividends. The bottom line is that the market isn’t expensive and so unless we really are headed for that dreaded double dip, the risk of buying the things here has just been reduced fairly dramatically. For a committed contrarian, that spells opportunity.

Commodities are a trickier story as valuing them is a bit more difficult than with stocks. How do you determine the proper value for a barrel of oil that produces no income? Anyway, the trend in prices last week indicates a signficant reduction in the economic growth outlook. Some might argue that the Fed should meet this double dip fear with another dose of QE but I wonder what the result of that would be if the market turns out to be wrong about future growth. There is an old saying on Wall Street that the market has predicted 6 of the last 3 recessions (or some similar combination of numbers) so old timers understand that “the market” isn’t always right about the future. After all, if no one market participant has a crystal ball what makes anyone think all of them together have any more of a clue?

For now, I think this is a growth scare that will prove to be exactly that - a scare. Until we get more economic evidence, all anyone can say for sure is that the outcome is still in doubt. I am looking to be a selective - very selective - buyer on this dip.