Weekly markets commentary – October 26, 2009

David Joy — Chief Market Strategist, RiverSource Investments

Expectations of economic growth

The advance estimate of third-quarter gross domestic product (GDP) will be released this Thursday with a widespread expectation that the economy grew for the first time since the second quarter of 2008. Consensus estimates for the pace of growth center around 3.0 percent at an annualized rate.

While positive growth will be welcome indeed, the components of that growth also will be important. Consumer spending certainly will be boosted by the "cash for clunkers" program, but what level of spending otherwise occurred is uncertain.

The impact of changes in inventory levels, government stimulus spending, and relative stability in housing activity will provide insight into the underlying health of the economy. Doubts persist regarding the strength of final demand. Many point out that, so far, evidence of strength mostly exists on the supply side of the economy, driven by special circumstances and targeted stimulus. Proponents of an economic "double dip" scenario argue that private demand will not be sufficiently robust once this stimulus, both fiscal and monetary, is exhausted and withdrawn.

Thursday's report will begin to clarify some of these questions, but it will not answer them. It is far too early in the recovery to know either the strength of the consumer contribution over time, or for how long monetary policy will remain as accommodative. At the very least, the report should show that the recession has indeed ended. How robust and how lasting the recovery will be will remain uncertain.

Earnings reports

Third-quarter earnings continue to show most companies exceeding bottom-line expectations. In fact, at roughly 80 percent, this quarter is on pace to exceed the record results of the second quarter. Despite that, stocks edged lower last week across the board, with the exception of tech and telecom. The dollar continued to edge lower as well, helping to push commodity prices of all types higher.

Interestingly, the dollar remains approximately 10 percent above its weakest levels of last year, suggesting that the unwinding of the flight to safety strength it enjoyed during the financial crisis has not been completely unwound, despite its 15 percent correction since March of this year.

The week ahead

Although the GDP report will dominate the economic headlines this week, there are several other reports that will be watched closely. The S&P/Case-Shiller Home Price Index for August will be released on Tuesday. It is expected to show the fourth-consecutive reading of higher prices. During the previous three months home prices rose 3.6 percent after bottoming in April. Unfortunately, they remain 30 percent below their July 2006 peak.

Also on the calendar is the consumer confidence index for October. This report has shown a great deal of volatility recently. It dipped in September and in July, and remains slightly below its May level.

It is hoped that, when released on Wednesday, new home sales for September will show the same buoyancy that existing home sales showed last week. September durable goods orders and the Chicago Purchasing Managers Index are also scheduled for release.

With the Federal Reserve's next meeting looming on the horizon for next week, it is fair to say that this week's data releases will be mere curiosities in comparison. What the Fed has to say about its intentions, especially with so much skepticism regarding real demand circulating about, will likely dominate the near-term psychology of markets.