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Slow Growing

While it will be a little while before the official call is made by the National Bureau of Economic Research, it appears that the recession ended sometime this summer and that the third quarter marks a return to domestic economic expansion.

Following 18 consecutive months of contraction, economic activity in the manufacturing sector returned to growth in third quarter. According to the Institute for Supply Management, the PMI pushed above 50% in both August and September, driven by gains in new orders and production. In particular, automotive demand received a boost this summer courtesy of the “cash for clunkers” program. However retail sales data indicates the surge in auto sector sales may have come at the expense of other retail sectors.

Private payroll employment continued to decline throughout the third quarter, albeit at a slower pace than the prior two quarters of this year. The unemployment rate rose from 9.5% at the end of the second quarter to 9.8% for the end of the third. The average duration of unemployment has extended to 26.2 weeks, which is up dramatically from the 18.7 week average one year ago and suggests a rise in the number of permanent job losses. At 9.2 million in September, the number of people considered part time for economic reasons remains essentially unchanged since March. The September labor report noted that for production and nonsupervisory workers average hourly earnings increased 2.6% over the past 12 months; however, due to declines in the average workweek, average weekly earnings for that group have risen only 0.8%. The implication here is that even when economic activity begins to improve, labor markets will remain weak for an extended period because employers will extend the workweek and transition par time workers to full time before adding any new jobs.

The Federal Open Market Committee (FOMC) maintained their target federal funds rate range at 0% to 0.25% throughout the third quarter. In both the August and September statements, the FOMC noted multiple areas of economic improvement. The Fed also established a framework for the coming months to pull back on the purchase of Treasuries, government agency bonds and agency mortgage-backed securities.

While the Treasury yield curve remained steep in the third quarter, yields fell across all maturities. The Barclays Capital Intermediate Aggregate Bond Index returned 3.2% for the quarter. Commercial-mortgage backed securities and home equity ABS issues led the Index followed by lower credit corporate bonds; Treasury debt lagged the Index.

Stocks continued to rally and the Standard & Poor’s 500 Index netted a 15.9% return for the quarter. All ten major industry sectors produced positive returns; financials lead the Index in gains followed by the industrials and materials sectors. Lagging the Index for the quarter were the telecommunications and utilities sectors. Within the U.S., small and mid cap stocks outperformed large cap stocks as the Russell 2000 Index returned 19.3% for the period. International equities fared better than domestic stocks with the EAFE Index gaining 19.5% for the quarter.

The third quarter rebound was fueled by government stimulus, inventory rebuilds and improving exports. Soft labor markets and anemic income growth will curb any upturn in consumer spending. Residential construction activity should remain repressed, and many businesses remain more focused on cutting costs rather than ramping up capital expenditures. Looking ahead we see a lack of drivers to boost final demand leading to an extended period of sub par economic growth. We have no immediate concerns about looming inflationary pressures. Core indicators like the August Consumer Price Index excluding food and energy rose only 1.4% year over year, and the core PCE deflator gained 1.3% over the same period; the excess slack in the economy will keep core inflation indicators subdued while providing the Fed with ample time to respond to any price instability.

As of Market close Wednesday September 30, 2009