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Economic Soft Spots May Soon Firm

Some growth indicators may be near the bottoms of their typical soft spot-driven decline and poised for a rebound.

If history is any guide, the disappointingly soft economic data over the past few months may soon begin to firm.

Looking back over the past 60 years, about one year after the start of every recovery a soft spot emerges. These soft spots weren't signs that the recovery was going to fail. In fact, in every case the recovery was successful and a multi-year period of economic growth followed. Some of the most current indicators of economic activity include the Institute for Supply Management Purchasing Managers Index, initial claims for unemployment benefits, consumer confidence, and the stock market. Around the time of these prior soft spots:

  • The ISM consistently fell back to about the break-even level of 50. In August, the ISM was reported at 55.5, on its way down from the recent peak of 60.4. This index remains above 50 and is unlikely to have completed the full decline associated with the soft spot.
  • The weekly number of first-time filings for unemployment benefits rose by 49,000. As of last week, jobless claims were up 73,000 from the low earlier this year, exceeding the typical rise by a potentially worrisome margin. However, President Obama on July 22 signed into law a measure restoring unemployment benefits to 2.5 million people. Since the passage of the law in mid-July initial claims for unemployment benefits have been on the rise. The extension of benefits at the end of July may be prompting Americans, whose assistance ran out, to file new claims causing the number of initial claims to rise rather than being driven by a new rising trend in layoffs. Supporting this notion is the fact that planned job cuts at U.S. corporations tracked by consulting firm Challenger, Gray & Christmas have been falling.
  • Consumer confidence declined by 13 points. The Conference Board reported in July that consumer confidence had declined 12.3 points from the recent high in May. The shaken confidence of consumers may begin to stabilize now that the typical soft spot decline has taken place. Daily and weekly measures of consumer confidence are showing an improving trend in August.
  • The S&P 500 fell about 7% below its 200-day moving average. As of July 2, the index had fallen 7.7% below the 200-day moving average. This is in line with the typical soft spot decline and suggests stocks may have already experienced the low point for the year. As of Friday, the index had recovered to 4% below the 200-day moving average.

The economic soft spot is likely to continue to unfold over the remainder of the quarter. However, some closely watched indicators of growth are likely to be near the bottom of their typical soft spot-driven decline and poised for a rebound. Notably, the weakness in the stock market, the labor market, and consumer confidence may have bottomed suggesting fears of a double-dip recession are overblown catching pessimistic investors by surprise.

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Supporting our outlook is the LPL Financial Current Conditions Index, a weekly measure of the conditions that we believe are most relevant to growth in the markets and economy. Although the CCI shows that growth momentum has stalled over the past three months, the vast majority of the 10 CCI components point to an environment of growth.

As the data begins to firm, the stock market may mount a fourth-quarter rally achieving the modest single-digit returns we have forecasted for 2010.