The State of the Economic Recovery
By Stephen Smith
February 4th, 2011
The economy is entering 2011 with good momentum. Many economists are lifting their 2011 Gross Domestic Product forecasts. The average forecast is currently running over 3.5% for 2011.
• The Leading Economic Index (LEI) increased 1% in December, rising for the sixth straight month and rising 19 of the past 21 months. Six of its ten components made positive contributions, led by building permits and interest rate spreads. Stock prices, another one of the LEI components, generated a repeat expansion signal for the economy, confirming the recovery is strengthening. The six month diffusion index rose to 80%, suggesting broad based strength among individual indicators. Additionally, the LEI annualized six month rate of change picked up 6.7% from 4.3%. Both of these indicators are consistent with robust economic growth.
• The Philly Fed Region activity remains strong. In January, the reading came in at 19.3 which indicates expansion for the fourth straight month and has increased 16 months out of 18 months. All individual indexes pointed to sustained growth. Notably, new orders rose 13 points to 23.6, the highest level since September 2004. Unfilled orders and inventories each rose to their highest levels since October 2006. The employment index surged 13.3 points, the most in over seven years, to 17.6, suggesting labor market conditions continue to improve.
• Existing home sales jumped 12.3% to a 5.28 million unit annual rate in December. It was the fourth increase in the past five months. Distressed properties continued to account for approximately one-third of all sales. First-time buyers also accounted for about one-third of sales. Investors accounted for one in five transactions. For the year, sales were down 4.8% to 4.9 million units, the fewest since 1997.
Our research providers are forecasting a return to normalization of volatility and returns. Intraday volatility has dropped for the third straight year in 2010, with the yearly averages for the Dow Jones Industrial Average and the S&P 500 volatility back to their historical norm. The same can be said of the year’s mean standard deviation of daily returns. Following the market melt down of 2008 where the S&P 500 was down 38%, the S&P 500 rally of 2009 up 23%, versus the more historical return of up 12% in 2010. The S&P 500 could return 8% in 2011 which is the mean return over the past 91 years. Our biggest concern going into 2011 is the surge in food and energy prices around the world that could hurt the global recovery. Also, if history is a guide, our short term indicators predict that the market is overdue for a pullback. The S&P 500 has gone over 100 days without a 5% pullback. The 83-year mean average is 50 days.
