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Second Half 2010 Starting With a Thud

This week was the start of earnings season, and so far you'd have to say that corporate performance in the second quarter of 2010 has been mixed, with some strong top line results but with questions about the future. It's the future that I'm most concerned about these days, and in a sense I am inclined to let second quarter earnings take a back seat to any forward looking data I can dig up. A few major factors loom large heading into the second half of the year that could change the face of the economy. Those factors are: 1) The hysteria surrounding European sovereign debt and the ensuing austerity efforts; 2) Economic cooling efforts in China including real estate tightening and decreased lending and; 3) The end of the homebuyers' tax credit and subsequent freefall in home sales.  Any one of these factors could (and may already be) derail a recovery, and all three in tandem could turn out to be disastrous. So then, let's take a peek at July and why it's not looking good.

Over the past few days, we've received a few early reports looking at July conditions. Those reports include the Philadelphia Fed Business Outlook Survey, the Empire State Manufacturing Index, and the University of Michigan/Reuters Consumer Sentiment Index.  Although the two manufacturing indexes (Philly and Empire State) are generally more volatile month to month, they broadly move in tandem with the consumer confidence index. Looking at the past two months, one could say that all three indexes have posted a relatively major decline, and July in particular has turned out to be quite worrisome. The Michigan Sentiment Index fell by 9.5 points to a reading of 66.5 from June to July to its lowest reading since last August, and the expectations component dropped to a reading of 60.6, representing the lowest level since March of last year. The last time the index fell this much was in October 2008 when Lehman Brothers bit the dust. The Philadelphia Fed and Empire State manufacturing indexes were at their lowest levels since August and December, respectively, and each of their readings reflects tangible declines in new orders and shipments of goods. All in all, the coordinated decline of all three indexes demonstrates that there is in fact something brewing and consumers are not simply freaking out over nothing.

We have also received weekly readings for mortgage purchase applications which track demand for home sales. We already saw applications plunge along with the expiration of the homebuyers' tax credit, and those applications have continued to decline, reaching the lowest level since 1996 for the week ended July 9 (more on this topic here). The Department of Labor's weekly jobless claims report was the one report that didn't dive, and in fact claims fell to 429,000 from 458,000 in the week ended July 10. That being said there were questions raised immediately following the report. The catch was that various automakers continued production when they usually shut down, and that skewed seasonal adjustments; the non-seasonally adjusted number was above 500,000. We will toss out the latest initial claims number, but keep in mind that it is still firmly above 400,000 and has stagnated at high levels throughout 2010.

So then, virtually all indications point to a downward shift in July. We aren't taking up a brace position just yet, as companies so far are showing that they are chugging along and posting improved bottom lines, which can in turn lead to hiring. However, I believe July has so far been, and will be, a rough patch. I would sit tight and invest carefully, as the market will run into some volatility assuming July economic reports will continue to discourage. Remember, the three major economic factors in Europe, China and the housing market have yet to be played out.

Disclosure: none