Today the government revised its estimate of second quarter Gross Domestic Product to a weak 1.6%, down from the original estimate of 2.4%. Equity markets cheered this news, with the S&P 500 gaining 1.7%, while Treasury yields rose substantially. Although the downward revision confirms the economy slowed considerably after April, investors evidently were relieved that the numbers were not worse. However, we can find no great comfort as the risk of even slower growth, if not outright recession, continues to rise.

Clearly, the extraordinary fiscal and monetary stimulus enacted over the past 18 months has failed to generate strong, sustainable growth. Consider the plethora of negative news over the past few weeks:

  • Real GDP growth has downshifted from 5% in the fourth quarter of last year, to 3.7% in the first quarter of this year, 1.6% in the second, and potentially below 1% in the third.
  • Existing home sales plunged 27% in July as government incentives to purchase homes expired. At the current pace of sales, homes on the market are taking a year to sell.
  • New home sales declined 12.4% to a paltry 276,000 annualized rate. Perhaps new home sales are approaching a bottom, but with high inventories and many more foreclosures to come, the housing market is likely to struggle for a long time.
  • Durable goods orders declined 0.3% in July against expectations for a 3% rise. Importantly, measures of corporate capital spending have recently disappointed.
  • Weekly new claims for unemployment insurance have averaged over 480,000 over the past month, indicating that employment is on the verge of worsening.
  • Intel warned that PC demand has weakened and the company lowered its earnings guidance for the third quarter. This follows similar cautious comments from other large companies such as Cisco Systems and IBM.

As for stocks, 1040 on the S&P 500 is a very strong support area. Following today’s negative news, the market touched and then rose strongly from this support level. However, we continue to recommend a defensive portfolio as the evidence suggests high risk of a renewed recession.


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