"Kee" Points with Jim Kee, Ph.D.

Market: Last week’s 2.5% gain - which pushed stocks towards their strongest monthly gain in decades - shocked a lot of investors who chose to wait on the sidelines. A lot of the market’s reversal of its negative third quarter momentum can be attributed to apparent progress in Europe. A second reason is the fact that 71% of companies beat earnings estimates for the third quarter. And finally, Thursday’s release of the Bureau of Economic Analysis’ Advance Estimate for third quarter GDP, which came in at 2.5%, relieved concerns that the U.S. was in or heading towards recession. Nevertheless, the market technicians are already warning of reversals. Reversals seem likely in this volatile market, but of course, no one really knows.

Europe: Anything that reduces the perceived risk of financial collapse is going to have a positive impact on markets. Basically, European leaders brokered a package last Thursday that would bolster their bailout fund, help recapitalize European banks, and reduce Greece’s debt load (WSJ). Although the actual details won’t be known for a few weeks (or even months), the gist of it is that the European Financial Stability Facility (EFSF) will have the expanded capacity to provide guarantees for $1.4 trillion in bonds (up from about $600bb). It is hoped that some of these funds will come from countries such as China, Japan, Brazil, and even Russia, perhaps with the IMF acting as the intermediary. Another key plank in the proposal was halving the value of Greek government bonds in private hands (the 50% “bondholder haircut”), which was also a crucial step towards a European solution. Of course, the European debt problem is ongoing, and I think it is safe to say that markets will be swinging up and down based upon European news – positive and negative – for months if not years to come. European economic growth is already waiting in the wings as the new headline concern when and if the debt problem gets resolved. And many feel that the act of writing off Greece’s debts will slow the implementation of necessary fiscal austerity measures there.

US GDP grows by 2.5% in the Third Quarter. We expected the second half to be stronger than the first, and Thursday’s 2.5% third quarter GDP number reaffirms those expectations (the economy averaged about 0.9% growth in the first half). Though 2.5% is not enough to generate new jobs, it does reflect an acceleration of growth throughout this year. Business spending on equipment and software surged 17.4% (even non-residential fixed investments rose 16.3%), and consumer spending increased (2.4%) as well. This supports the observation that many of the relationships between widely watched indicators and the economy have not held up during this expansion. That includes the ISM Purchasing Managers Indices, the Philly Fed index, and even the UCLA-Ceridain Pulse of Commerce Index. Kind of recalls the first lesson I learned as a macroeconomist, which was, prices lead quantities. Market-based or “price” data like interest rates, the slope of the yield curve, and credit spreads, contain more forward-looking information than quantity data like employment, GDP, or even industrial production (quantity data is sample-based, backward looking, and usually gathered with a lag). Since price-based indicators have not been signaling recession (while many quantity-based indicators have been ambiguous), the notion that prices lead quantities continues to be a piece of wisdom worth hanging on to. Also, Kee Points readers know that GDP exhibits strong seasonality. That is, some quarters are regularly weaker or stronger than others. The first quarter is by far the weakest on average. Keep that in mind when the headlines start anticipating firstquarter numbers. Finally, various estimates for the fourth quarter and for 2012 GDP growth seem to fall in the 2% range.

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