Comstock: It’s More Than Just A “Scare”

Below is the weekly commentary from Comstock Partners.

The softening in the economy that we have been looking for is now becoming a reality as a wide sampling of the latest monthly or weekly economic releases clearly indicates that a slowdown is now underway. We cite the following.

On the consumer spending front, May retail sales were down 1.1% and anecdotal reports from various retailers indicate that June appears to be weak as well. The labor situation seems to be fragile as private May payrolls were up only 41,000 and weekly initial unemployment claims have been stuck in a range since November. As we previously pointed out, housing has probably started a renewed downturn. The Mortgage Bankers’ Association pending purchase applications index has dropped 40% since the ending of the homebuyer tax credit on April 30^th. This is the best leading indicator of future home sales. Monthly new home sales were down 32% to at least a 40-year low, while existing home sales declined 2%, housing starts 10% and building permits 6%. The ISM manufacturing index dropped last month, and current regional Fed indexes from New York, Philadelphia, Richmond and Kansas City indicate continued weakness.

The widespread current declines are supported by evidence from ISI’s weekly company surveys. Their overall index peaked in April and has since been trending down. On an industry basis the ISI retail survey dropped 4.8% last week and 20% since the April peak. The homebuilders’ survey is at a 4-month low, while the employment survey dropped 3.1% last week and 7% from the recent peak. The transportation survey declined the last four weeks. Semi equipment orders grew only one percent in the latest month, compared to an average of 13.5% over the prior five months.

Generally the indictors showing the most weakness are those that lead the economy—housing, initial claims and consumer spending. This is consistent with the ECRI weekly leading indicator where the latest smoothed growth rate is minus 5.7%, a level that has led the last seven recessions and been wrong only once.

For some time we have believed that the economic recovery was unsustainable as it was supported mainly by government transfer payments and lacked the usual impetus that normal recoveries get from housing, consumer spending and easy credit. Moreover it has been our view that both domestic and global debt was far too high and that the necessary deleveraging would lead to slow growth and more frequent recessions.

For those reasons we believe that current investor concern is fully justified. The market, at current levels is discounting a far stronger economy than is likely to develop in the period ahead. Even if the economy does not undergo a double dip, a slowdown in GDP to 1 or 2% would have highly negative consequences for housing, employment, consumer spending, financial company balance sheets and corporate earnings that is not currently discounted in the market.

Indeed the market technically appears to have formed a potential top in the last few months with a range in the S&P 500 of 1219 on the upside and 1040 on the downside. The last rally stopped at 1131 and appears headed for a test at 1040. Although another rally is still possible, we think that further deterioration in economic growth—-which we expect—-will drive the market well below the 1040 level, and that an eventual test of the March 2009 lows are not out of the question.

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