Markets received a little dose of reality last week, declining for the first time in five weeks due to disappointing news on the health of over two-thirds of the U.S. economy. Amid all of the recent talk of the imminent end to the recession, several data points released last week show the U.S. consumer is far from ready to drive a recovery. Consider these headlines from the week:

  • July Retail Sales declined 0.1%, far below expectations of a 0.8% increase. Excluding automobiles, sales fell 0.6%, versus an expectation of a 0.1% gain. While the pundits claim the “Cash For Clunkers” program a huge success, it appears consumers simply took advantage of the government’s transfer payments to buy cars at the expense of refrigerators, washing machines, furniture, etc.
  • Consumer Confidence, measured by the University of Michigan, declined to 63.2, against expectations of a rise to 69.0.
  • Wal-Mart’s same-store sales dropped 1.2% last quarter. The company’s CEO believes, however, that the company gained market share. What does this comment mean for the rest of retail?
  • Other retailers reported revenue declines, including JC Penney and Abercrombie & Fitch.
  • New claims for unemployment benefits reversed a positive trend, rising to 558,000.
  • Deutsche Bank forecast that underwater home loans (where the loan exceeds the value of the home) will rise from the current 26% to nearly 50% of all residential mortgages by 2011.
  • Home foreclosures in July, reported by RealtyTrac, increased nearly 7% from June to a monthly record 360,149 properties. See the chart below comparing foreclosures and unemployment, suggesting that housing won’t see a bottom before job growth returns.

Tough Week

All of this data is further evidence that the cheerleading practiced on Wall Street and in the financial news media regarding the end of the recession is premature. While much of the data has gotten much less bad, it seems clear that government spending is responsible for most of the improvement. Our concern is that, with trillion dollar deficits and a consumer that has only begun to de-leverage, the markets are pricing in a recovery that is unlikely to be as strong as expected.

Finally, an article caught our eye last week on the health of the U.S. banking sector. As Friday’s failure of Colonial Bank in Alabama indicates (the sixth-largest failure ever), the toxic assets still on the books of the nation’s banking system remain a threat. See this Bloomberg article Toxic Loans Topping 5% May Push 150 Banks to Point of No Return.

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