The Good, The Bad And The Ugly (Part II)

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 |  Includes: DIA, QQQ, SPY
by: Bret Jensen

Yesterday, I laid out what is going right for our economy & markets as part of a three part series named the "The Good, The Bad and The Ugly". Today, we will look at three major concerns investors should have right now domestically about growth in the economy and equities going forward into the summer: "The Bad".

Economy/Job Growth is tepid -

  • Chicago PMI came in yesterday at 49.0. It was first time the reading has breached the 50 level (Under 50 denotes contraction) since September 2009. The employment component of the index had its third straight month over month decline. The employment part of the index is now in contractionary mode as well, at 48.7.
  • This follows a 1st quarter GDP report that came in much weaker than expected (2.5% versus 2.8% to 3% expectations). This follows growth of just .4% in the fourth quarter of 2012. In addition, many have rightly pointed out that the first quarter report was much weaker than reported.
  • The ADP report for April just printed at 119,000, much lower than expectations of 155,000 jobs created in the month. The marks a seven month low (See chart at end of section). The March report was also revised down 27,000 jobs to 131,000.
  • The sequester cuts are just starting to hit and more importantly the $150B to $200B annual hit caused by yearend tax increases and the expiration of the payroll tax holiday are starting to impact consumer spending. Year end bonuses, special dividends and tax refunds have helped mitigate the hit so far but those tailwinds have run their course. Notable is that the savings rate has fallen significantly over the last few months.

Click to enlarge

Revenue growth is non-existent -

  • More than halfway through earnings season and only 43.9% of S&P 500 companies have reported revenue figures ahead of analysts' expectations, according to figures compiled by Thomson Reuters.
  • That "beat rate" is on pace for the fifth lowest mark since the firm began compiling this data in 2002.
  • Overall sales results are down 0.3% from a year ago, on pace for only the second negative quarter since 2009.
  • It goes without saying that companies that are showing no revenue growth are going to be very reluctant to hire. In addition, with S&P margins are at all-time highs after numerous rounds of deep cost cutting, this will eventually cause a deceleration in earnings.

Weak recovery continues -

  • We can have arguments about the causes, but the facts are clear. 15 quarters after the recession officially ended, we have averaged tepid 2.1% average quarterly GDP growth since the end of the contraction. This compares with 4.4% average quarterly GDP growth coming out of the last 9 recessions and 5.3% average quarterly GDP growth for 15 quarters coming off that last deep contraction in 1982.
  • Given that we have the same players (Bernanke, President Obama, Congress) that we have had in place over the last few years; can an investor expect any different policies that could ignite economic & job growth in the year ahead? Given the recent fiasco around a paltry 4% cut in the FAA budget, thinking these parties can come together and make a "grand bargain" that could reassure business and investors that we are righting the ship seems far-fetched at best.

Given this state of affairs, investors should take a couple of actions. First be grateful. As bad as things are here economically, they are much worse in Europe and Japan. Second, allocate more to stocks that can still be counted on to deliver sales growth at reasonable valuations. Microsoft (NASDAQ:MSFT) which I profiled yesterday falls into this category. Cheap stocks with high yields like BP plc (NYSE:BP) also offer shelter in what looks like could be another second quarter swoon.

Tomorrow: "The Ugly"

Disclosure: I am long BP, MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.