MarketView for July 31

Summary  

Although it was starting from a low level, the S&P 500 index turned it its best 5-monthy performance since 1938. The continuing positive gains received support from the latest reading on Gross Domestic Product or GDP that was released on Friday. The news reinforced expectations that the economic slump is abating, despite the continuing softness in consumer spending. Meanwhile, the Dow Jones industrial average turned in its best July performance since 1989 while the S&P 500 and Nasdaq recorded their best gains for July since 1997.

Nonetheless, the atmosphere on the Street remained one of caution as the report on second-quarter gross domestic product indicated that consumer spending remained under restraint, which is healthy for the economy in the long run but hurts demand in the short-term. Commodity prices, a barometer for economic sentiment, moved higher after the GDP data, but the price of Treasury debt also rose in a sign of underlying caution.

Trading was volatile as investors digested mixed news from the GDP report. Consumer spending, which fell in the quarter, is a crucial driver of corporate profits and the economy. GDP fell at a 1.0 percent annual rate in April-June after tumbling 6.4 percent in the first quarter. Economists had expected a 1.5 percent contraction in the second quarter.

For the week the Dow rose 0.9 percent, the S&P 500 gained 0.8 percent and the Nasdaq added 0.6 percent. For July the Dow gained 8.6 percent, the S&P added 7.4 percent and Nasdaq rose 7.8 percent. Another report showing that business activity in the U.S. Midwest was the strongest in July in 10 months also lifted stocks.

Travelers was a standout following positive broker comments, a day after it raised its forecast for the year. Its shares ended the day up 2.7 percent to close at $43.07. On the downside, Walt Disney fell 4.2 percent to $25.12. The company reported a 26 percent decline in quarterly earnings late Thursday as the recession continued to hurt advertising and consumer spending. Even though Disney beat expectations by a hair, its shares were the Dow's top drag. JPMorgan downgraded the stock to "underweight" from "neutral" on Friday.

In other earnings news, Chevron posted a 71 percent earnings fall the result of weaker energy prices and fuel demand due to the recession. However, the company raised estimated 2009 output and said cost cuts were on track. The shares ended the day up 2.6 percent to close at $69.47.

Economy Shrinks Less Than Expected

The deepest recession since the Great Depression showed signs of easing in the second quarter, raising the distinct possibility that we will see an economic recovery during the second-half of 2009, although it may be anemic as consumers are still strapped for cash.

Gross domestic product, which measures total goods and services output within our borders, fell at a 1.0 percent annual rate in the second quarter, the Commerce Department said on Friday, after falling 6.4 percent in the January-March quarter, the largest decline since early 1982. Nonetheless, the report provided the clearest evidence yet that the 19-month-old recession was almost over.

The International Monetary Fund in its annual report on the U.S. economy said the recession seemed to be ending but cautioned recovery would be slow. On a year-over-year basis, second quarter GDP declined a record 3.9 percent. Previously, the government said GDP had fallen at a 5.5 percent annual rate in the first quarter but it revised that to a steeper fall. Including the second-quarter contraction, GDP has fallen for four straight quarters -- the first time that has happened since records were started in 1947.

A steep drop in consumption spending, the main engine of the economy, fanned fears of a sluggish growth pace assuming the economy does recover as anticipated in the second half. Consumer spending, which accounts for over two-thirds of U.S. economic activity, fell at a 1.2 percent rate in the second quarter after rising 0.6 percent in the previous quarter. That sliced 0.88 percentage points from second quarter GDP, the department said.

In contrast to the weak consumer reading, business investment improved significantly in the second quarter. The report showed business investment decreased at an 8.9 percent rate in the second quarter after diving 39.2 percent the previous quarter. Investment in nonresidential structures fell at an 8.9 percent rate compared to a 43.6 percent drop in the first quarter.

Residential investment, which is at the core of the downturn, dropped at a 29.3 percent rate in the April-June period after plummeting by 38.2 percent in the first quarter. Business inventories continued to be a drag on overall GDP, declining by a record $141.1 billion in the second quarter as firms aggressively cut back on new production to reduce stockpiles of unsold goods.

The drop in inventories shaved 0.83 percentage point from second-quarter GDP, but was seen providing a springboard for the much-anticipated economic recovery in the second half. Excluding inventories, GDP fell 0.2 percent in the second quarter compared to a 4.1 percent drop in the first quarter.

A free-fall in exports braked sharply in the second quarter. Exports fell at a 7.0 percent rate after plunging 29.9 percent in the first quarter. There were positive contributions from the federal, state and local governments during the quarter.

Annual benchmark revisions issued by the department showed the economy barely grew in 2008, expanding at an annual rate of 0.4 percent, the smallest since 1991, instead of the 1.1 percent previously estimated. They also showed the decline since the recession began in 2007 was steeper than previously thought. From the fourth quarter of 2007 to the first quarter of 2009, real GDP fell at an average annual rate of 2.8 percent instead of a 1.8 percent decline.

Appropriated Funds Not Being Spent

Congress on Friday chastised federal agencies for delays in starting capital works projects under the economic stimulus plan, saying they were lessening the impact of the $875 billion program intended to revive the economy.

"I'm troubled that there is considerable unevenness in the implementation in non-highway and transit agencies," said Transportation and Infrastructure Committee Chairman James Oberstar at a hearing.

In a report the committee released this week, almost all of the infrastructure-related jobs created or saved by the stimulus were in highway repairs. The clean water portions, which involve state revolving loan funds, had created or saved barely any.

"State Revolving Loan Funds are not moving their projects out as fast as I anticipated and as fast as the SRF managers told us they would be able to do last December and early in January," Oberstar said.

Craig Hooks, acting assistant administrator of the Environmental Protection Agency, told the hearing much of its stimulus money has been made available to states. Of the $7.22 billion given to EPA under the American Recovery and Reinvestment Act, it has obligated, or pledged to spend, more than $5.8 billion.

"We actually are concentrating our efforts in assisting the states in breaking down any sort of barriers they may have," he said.

The few projects that have started are expected to ramp up significantly in the next few months, he said. However, Congress remains concerned.

"When I look at the number of contracts that are out to bid, it's just state after state, zero after zero. The number of jobs that are created or sustained -- zero after zero," said Maryland's Donna Edwards. "If we're out there telling the American people we put out all of this money that's being paid for by their children and their grandchildren, surely we've got to be creating jobs."

Anthony Costa, acting commissioner of the public buildings service at the General Services Administration, said his agency has already obligated $1 billion of the $5.5 billion it was allotted for the plan's two-year life and is on track to obligate another $1 billion by the end of the calendar year.

The Army Corps of Engineers, meanwhile, has distributed $3.5 billion of its $4.4 billion to field offices to begin civil works projects. But only $684 million has been obligated in contracts and $84 million made in outlays, Terrence Salt, Acting Assistant Secretary of the Army told the hearing.

While the Transportation Department did not testify at the hearing, the Government Accountability Office, the independent government auditors, said that $16.8 billion of the $48 billion designated for transportation projects over two years has been obligated to more than 5,700 projects nationwide. Almost half of that money has gone to road repair.