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This week should be fairly busy with market moving data points and bond auctions which will help gauge the economic recovery that we are told is happening now. The biggest data point, in my opinion, to watch is consumer spending which economists expect to grow at 50% of June’s rate. June delivered a ‘strong’ .4% increase in spending and July has a medium estimate of a .2% increase.

I have no idea which way the number will come in as the bar is set fairly low and people are out spending for back to school items. I believe there is a case for either an upside surprise or very dismal results. In general, I believe spending will continue to decline as unemployment appears to be on the rise again, but July may surprise us to the upside as sales and deep discounting of products is attracting consumers. However, discounted products squeeze profit margins and employers are getting more out of their existing workforce, mainly because people need to keep their jobs, but lower profit margins make it impossible to keep people employed.

The Case for an Upside Surprise

According to Bloomberg purchases, excluding automobiles, dropped .6% as of August 13th. They went on to say that retail sales slipped .1% in July which leads me to lean towards an upside surprise in consumer spending. Mostly because of pent up demand, we love to spend money, along with deep discounts and kids just a couple of weeks to get ready for their first day of school are a recipe for a surprise. Frankly, the ingredients are there for people to spend more as they are told the economy is recovering and stocks are up.

Perhaps June’s numbers were so bad because people where saving money for July and August to buy their kids new clothes. If that is the case then we definitely could have a, albeit short-term, surprise to the upside which will surely cause the market to add 100 or so more points to its overbought averages. If we do get an upside surprise I am sure it will be a one-off event as people really are hurting.

The Case for a Downside Surprise

While people are told things are better, they know better because they live in the real world and not in statistics. Unemployment has been creeping up over the last two weeks and many people have lost access to emergency unemployment benefits which means hundreds of thousands of people are absolutely broke. For those who are employed, their falling home value and massive stock market losses from last year make them feel especially poor.

Not to mention, their credit card bills just went up by 2% and they either closed some credit cards or the credit card issuer closed the account for them. Either way, they have less available credit to buy things and cash, frankly, is in short supply. However, the kids have to have the new Nike’s or Guess jeans or whatever is cool and obscenely expensive nowadays and who are parents to say no. There is also the likelihood that people blew their money on a new car with the cash for clunkers program. A surprise to the downside would mean that the Dow would probably come off a good 50 points as it, inexplicitly, does not go down now, ever.

The End Result

No one has any idea what the number in store for us is, and I am much more interested in the unemployment numbers that will be out Thursday. Contrary to popular belief, I see unemployment as a leading indicator for our current problems as this is a credit led recession, unlike other recessions we have had in recent decades. I am sure that the markets will blow off any bad news and continue to trade in the top end of its current range. Frankly, the market's behavior makes no sense to me as it is so overbought right now and, regardless of what they say publicly, no one has a real explanation for its rapid and sustained gains.

The really good news is that I have also noticed that the crowds picked up at stores in the last month which means they may be out spending money. However, I am willing to bet the average transaction size is much smaller than it was last year at this time. Either way the numbers come out, I am sitting out of equities with only 25% exposure, the risk/reward ratio is just not attractive, and am looking for a sharp decline in September or October when liquidity returns to the market. While I could be wrong on the timing, I am not wrong overall as the markets have 4%+ GDP growth and a lot of very, very, good news priced into it right now.

Source: What Will Fuel the Next Market Rally?