PNC Outlook: 'Half-Speed' Recovery

PNC forecasts there will be a transition into a self-sustaining economic expansion in 2011 -- which includes continued improvement in employment.
By Bill Stone ,

NEW YORK (TheStreet) -- Market participants anxiously awaited the November employment report released on Friday for further signsof the direction of the economic recovery. In our view, employment is certainly the most important factor stillneeded for a sustained economic recovery and to continue supporting the financial markets.

Despite the growing optimism of forecasters (including PNC), job growth was up only 39,000 jobs in Novemberversus consensus estimates of 150,000 jobs. In addition, the unemployment rate rose to 9.8% from 9.6%. Thisdata was clearly a disappointment, but we believe it understated the improvement in the job market.

Payroll numbers are notoriously volatile, so we would first point to the longer trend which shows positiveprivate payroll growth for eleven straight months. Smoothing the data over the past three months shows anaverage private job growth of 107,000 jobs per month.

It is also worth noting that on a non-seasonally adjusted basis, nonfarm payrolls actually increased by217,000! This seasonal adjustment helps explain, in our opinion, the anomaly of retail trade jobs falling by28,000 in the report despite a strong start to the holiday shopping season. It is likely that there is significanthiring going on but just not as strong as in an average holiday season.

Our view is that the pattern of upside surprises in most recent U.S. economic reports supports both acontinued sustainable recovery and an improvement in the job market. Among the factors to consider:

A recent recovery in consumer spending as evidenced by (1) a strong start to holiday spending and (2)most retailers reporting November comparable store sales above consensus estimates. In addition,auto sales were recently reported at an above-estimate 12.26 million annual rate for November.

The November employment component of the ISM nonmanufacturing index, reported the same day aspayroll employment, reached 52.7 which is a good leading indicator of future employment gains. Evenwithin the soft payroll employment report, temporary help rose by 40,000 - another good indicator offuture employment growth.

The November employment component of the ISM manufacturing index was also reported last week,at 57.5. This measure has been above the expansionary 50.0 level since December 2009 and continuesto indicate better employment prospects.

Initial jobless claims, which have been one of the timeliest indicators in terms of judging the strengthof both the economic downturn and the recovery, are clearly showing a downside breakout. The mostrecent four-week moving average has declined to 431,000 after the lower boundary being roughly450,000 all year.

Taxes

As expected, both Democratic proposals to extend some portion of the Bush tax cuts were defeated over theweekend, meaning that the negotiations will continue. Recall that unless action is taken, the Bush tax cutswill expire at year end -- raising both ordinary income rates in addition to capital gains and dividend rates.

Our expectations are that the Bush tax cuts eventually will be extended for some period, perhaps two to three years.

Game theory would indicate that a deal will be reached by year end though time grows short. Democrats arewell aware that the Republicans will just pass their own plan next year if a deal is not reached now. This mayalso be the last chance for Democrats to pass an extension of the unemployment benefits before theRepublicans gain control of the House. President Obama noted his wish for extended unemployment benefitsas part of any deal, and this may signal a future possible compromise.

The key dates to watch are in the weekleading up to Saturday, Dec. 18. This is the expiration date for the current continuing resolution to fundthe federal government -- giving an opportunity for a deal to be reached to extend the tax cuts and funding.

Unfortunately, there is still the possibility that the two sides will remain at an impasse. In that case, we expectthe Bush tax cuts to be extended sometime in early 2011.

The financial markets will likely become morevolatile if Dec. 18 passes without a deal; investors will consider taking gains at the lower level notwanting to risk the capital gains uncertainty of next year and concern grows about the durability of theeconomic recovery in the face of tax increases.

PNC Investment Strategy Conclusions

PNC forecasts that in the end, "what we need" will be realized in terms of the economy and tax policy. Weremain convinced that there will be a transition into a self-sustaining economic expansion in 2011 -- whichincludes continued improvement in employment. Our forecast for a continued "half-speed" recovery remainsand, in fact, we recently reduced our probability estimate for the adverse "double-dip" scenario.

Market volatility may remain somewhat elevated for the foreseeable future as the uncertainty around taxpolicy continues. In addition, concerns regarding the European sovereign debt issues, Chinese policy actions,and Korean geopolitical risks are likely to continue intruding occasionally.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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