July Economic Indicators And The Outlook For Equity Markets

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Includes: DIA, IVV, IYY, SPY, VTI
by: Julie Young

In June, the U.S. economy was impacted by low inflation, stagnant labor market growth and ongoing debt issues in the euro-zone. Despite the headwinds the S&P 500 gained 4.12 percent and finished June up 9.49 percent for the year.

In July the outlook was slightly more optimistic. The Conference Board reported a gain in its Leading Economic Index of 0.4 percent and the S&P 500 continued to gain, adding 1.39 percent and pushing to 11.01 percent for the year.

Inflation

In July, inflation continued to remain subdued. The Consumer Price Index was unchanged for the month and up 1.4 percent annually. Energy prices declined for the month by 0.3 percent and pushed the 12-month Energy Index measure down by 5 percent. Meanwhile, food prices increased 0.1 percent for the month and the Midwestern drought has led to a 2.3 percent increase in the Food Index for the 12-month period.

Similar results were also found in the July Producer Price Index which rose 0.3 percent for the month resulting in a 0.5 percent increase for the 12-month period.

The Bureau of Economic Analysis' most recent report on Personal Income and Outlays stated an improvement in personal income for the month of June but reported a decrease of less than 0.1 percent in personal consumption expenditures. The PCE Index, which measures personal consumption expenditure price levels, was up 0.1 percent from the previous month and increased 1.5 percent on an annual basis.

Given the low risk of inflation presented in these three key inflation indicators, the Federal Reserve can focus its economic stimulus plans on other areas of the economy without fear of increased near-term pricing pressure.

Economic Concerns

Areas that are currently causing concern for the U.S. economy include weak GDP growth and worsening labor market conditions.

According to estimates from Freddie Mac, third quarter GDP is expected to increase by 2.5 percent. A 2.5 percent increase for the quarter would be an encouraging sign following the second quarter's meager 1.5 percent gain. Fourth quarter estimates by the GSE appear to show some signs of further improvement but with GDP growth averaging 2 percent annually the economy still appears to be maintaining a slow recovery pace.

Further economic concerns center around the labor market which reported an increase in the unemployment rate for July of 0.1 percent.

Consumer Sentiment

Despite the slowed GDP and labor market growth, consumers increased their spending at retailers in July. According to the Commerce Department, retail sales improved 0.8 percent for the month after falling three consecutive months. The July increase resulted in an overall improvement in retail spending of 4.1 percent annually.

Motor vehicle sales led the overall improvement gaining 0.8 percent for the month and 8.2 percent annually. Meanwhile, clothing retailers increased sales 0.8 percent in July and 5 percent for the 12-month period.

Consumers continued to report a negative outlook on the economy in July mainly due to unresolved political issues, according to the Thomson Reuters/University of Michigan Consumer Sentiment Index. The Index decreased again in July to 72.3 from 73.2.

Equity Market Outlook

GDP and labor market growth continue to cause concern for the U.S. economy and equity markets but political issues still appear to be the greatest influencing factor in the months ahead.

Tax relief provisions set to expire in January are adding to economic burdens and would greatly increase tax rates for consumers if extensions are not enacted. Further fiscal tightening is also set to occur in January which could decrease the federal deficit to $641 billion in 2013, according to the Congressional Budget Office, but would have drastic effects on economic growth due to decreased consumer disposable income and labor market downsizing.

According to industry analysts, the debt ceiling is also expected to be reached again in December which would require political debate on a new statutory federal debt limit. Last August the level was increased to $16.39 trillion and in December that limit is expected to be reached.

Despite the uncertain political direction for 2013, equity markets have continued to gain through July and the S&P 500 is currently trading at its highest levels for the year. Many analysts, however, expect declines across all sectors if tax cut extensions are not enacted and consensus is not achieved in Congress on the federal debt. Equity markets reacted negatively to last year's debt ceiling debates and if similar policy debates occur, speculators predict year-end S&P target levels to drop to 1,250 with average price-to-earnings estimates for the S&P 500 falling to 13.75 from 16.13.

Given the market's continued uncertainty, municipal bonds and tax-managed funds continue to provide shelter for investors from tax rate increases. Municipal bonds offer tax-free investment at the federal and state level. Year-to-date the Barclays Capital Municipal Bond Index has returned 4.90 percent.

Dimensional Fund Advisors and Eaton Vance have led the tax-managed equity category. Dimensional Fund Advisors' core Tax-Managed U.S. Equity Portfolio (MUTF:DTMEX) has a year-to-date total return of 12.40 percent and a net expense ratio of 0.22 percent. Eaton Vance offers a Tax-Managed Value Fund (MUTF:EATVX) that has outperformed its peers in the tax-managed category gaining 12.35 percent year-to-date with an expense ratio of 1.17 percent.

The U.S. housing market has also been gaining momentum in 2012 and is one industry that could continue to improve despite political turmoil. Housing starts have shown increasing potential for continued improvement and the U.S. Commerce Department's July New Residential Construction report further supported the strengthening in the construction industry. The release stated annual rate increases for building permits, housing completions and housing starts.

Within the S&P 500 Consumer Discretionary Sector residential builders, PulteGroup Inc., Lennar Corporation and D.R. Horton Inc. have shown improved stock appreciation in line with the projected housing construction growth, respectively gaining 111.09, 63.61 and 49.82 percent year-to-date.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.