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Economic Update for the Week of 10/26/2012

The pain of earnings season misses continues with UPS and others, a light report from Apple, and a loss from Amazons pull the financial markets down further. So far, 59% of companies reporting earnings have missed their earnings estimates. The weak earnings does not surprise me rather the time for this to start happening does. As I have been writing about for some time, many economic metrics have been coming in weak or declining and now we are beginning to see this show up in the earnings reports and thus the effect they have on investors and the markets. 

The economy is not coming apart, yet, but it is certainly not shooting higher; there is clearly a slowdown at hand in addition to other issues occurring in the global economy. Are we reaching the point where investors finally recognize that the monetary stimulus efforts by the Fed are not leading to economic recovery? 

New home sales moved up from 373,000 to 389,000 on an annual basis. Inventory is down and sales are moving up which is a good sign. We need to put this into perspective which is this level of sales is only about 25% of the sales recorded at the peak in 2005 so there is a long way to go however this is a nice bounce from an, albeit, low level. Pending home sales on the other hand was up 0.3% following a 2.6% decline last month which tells us that the housing market is still relatively flat. 

Durable goods (items that last more than 3 years) were up 2% following a 2% decline in the previous month which makes the trend about flat. Jobless claims fall from 392,000 to 369,000 confirming that employment isn't getting better despite the massive rebound to 389,000 last week. 

3rd quarter GDP advanced estimate comes in a 2%; this number will be revised twice in the months ahead (2nd estimate at the end of November and the final number in December) and my money is on a final number under 2%. Companies are missing earnings estimates, exports are slowing down, Europe, China and Japan are all suffering, jobless claims remain elevated, labor force participation is low, etc., and the economy is growing at 2%? Yeah I'm sure that is the case (please note the sarcasm). Government spending added 0.71% to the gain which is no way to build a recovery. What happens when the Government cannot keep spending at this level, well GDP will weaken and we go into recession. Simple. 

We are seeing this now in countries like Japan. Japan needs to sell another $470 billion of bonds to fund its deficit, however there is political opposition. If the debt does not get placed, then the Japanese Government will face a crisis. Government deficit spending sounds nice but only works if there are those who are willing to lend the government money. Japan has been able to accomplish this for quite some time mostly due to internal purchasing of their own debt from pension funds, Japanese investors, and Japanese corporations. When they can no longer finance their deficit spending through internal bond purchasing, then Japan will have to go to the open market which will charge much higher rates. When that happens, all the old debt that matures has to be refinanced at higher rates and then your interest payments become a larger percentage of the government spending and you get to the "end game" as author John Mauldin says which in Japan's case is a "bug in search of a windshield." This will also happen here in the US if we don't get our spending under control. 

Commodity prices fell over the last week and last month, with gold falling almost $100. This is what I've been warning of for some time now. As the global economy slows down, even after massive efforts to stimulate economies, commodities will tumble. Most people believe that the stimulus, or money printing, causes commodities to rise however the reality is when we have deflationary forces at work, all asset prices can go down. The current decline may be temporary with a greater drop in the spring after the relief of the US Presidential Election has gone away and we are right back in the throes of the tax and spending arguments. 

With the election fast approaching, weak economic data, weak corporate earnings data, a slowing global economy, and markets near all time highs, we need to recognize the enormous risk that has built up in the financial markets and remain/be cautious until there are clearer signals that the economy is truly recovering at which point it will be time to put more capital at risk. 

Next week will have a variety of key economic measures being reported, so stay tuned.

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