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Investing Specialists

Watch the Horizon, Not Your Feet

Many recent problem spots in the economy will rectify themselves in the third quarter--perhaps dramatically so.

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After six weeks of declining markets and a generally softening economy, three key indicators--a surprisingly strong purchasing managers' report, reported increases in housing prices, and reported increases in pending home sales--drove the market up by over 6% in just a week. Commodity prices continued to fall for the most part, potentially putting more cash in consumers' pockets in the months ahead. And consumers kept spending, as the weekly chain store sales report posted its best sequential improvement since January. The Greek debt situation appeared to be kicked down the road for a few more months at least.

While the news this week was clearly better than expected, it wasn't like every indicator went straight up or was overwhelmingly bullish. It just wasn't as bad as people expected. After six weeks in the bomb shelter, it didn't take much to get people excited about the market. The market seemed not to care about a poor spending and income report on Monday, an initial unemployment claims report that remained stubbornly high, and auto sales that remained far softer than earlier in the year. May construction figures were also a downer, but again that was probably weather-related, and improving weather in June should mean better news ahead. I also continue to worry about second-quarter GDP forecasts that appear to be too high at 2.3% compared with 1.9% in the first quarter. Poor auto production and low construction spending will make it exceptionally difficult to get above the first quarter's growth rate. Those are problems that will rectify themselves in the third quarter--perhaps dramatically.

Watch the Horizon, Not Your Feet
These statistics all have a short-term focus. Over the longer term, I think auto sales have considerable room for improvement and housing has yet to give the economy any kind of lift. The manufacturing sector, while subject to many ups and downs, is poised for one of its best recoveries of the last 25 years. Consumer spending on debt service also continues to fall dramatically, giving consumers the wherewithal to buy some of those factory goods. So far, consumers have continued spending (ignoring the ups and downs of oil and autos) despite some pretty impressive headwinds. I am hopeful that our soft patch will turn out to have been driven primarily by a run of bad weather and the Japanese disaster in what has otherwise been a painfully slow but relatively steady recovery.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.