David Kelly: The end of the first chapter of the economic recovery

The following is market commentary from David Kelly, chief market strategist at JPMorgan Funds, for the week of July 26. In some ways, this week will mark the end of the first chapter of the economic recovery. On Friday, the government will release its initial estimate of second-quarter GDP. While the number itself may be on the soft side – we expect something close to 2% growth annualized – the government will also revise all the GDP data going back to 2007. This will give us a revised look at both the depth of the recession and the strength of the recovery thus far. Presumably, in the aftermath of this report, the National Bureau for Economic Research will finally declare that the recession came to an end in the middle of 2009 and that we are now entering a second year of expansion. While this will be an important milestone, other numbers due out this week will remind us how far the economy still has to travel on the road back to full health. • New home sales may show only an anemic rebound from their lowest level in almost 50 years of monthly data. • Consumer confidence and consumer sentiment should meander at exceptionally low levels, • The Chicago manufacturing index, while still indicating growth in the manufacturing sector, should show a deceleration in activity, and, • Compensation growth may have slowed in Q2 as employers took advantage of a weak labor market. Overall, the economy is still recovering. But it is like driving a fast car with the handbrake on…it's not moving nearly as fast as it should. The stress tests on European banks, published last Friday, may also constitute the end of a chapter. The adverse scenario used in these tests may not have been dire enough for the most goulish of market observers. But over the last few months investors should have picked up on two very important messages from Europe. First, it is clear that most European banks are, in fact, very well capitalized as of right now and that they are continuing to grow stronger. Second, it is clear that European governments are capable of acting in a coordinated way when they have to and are determined to fight to protect their common currency and avoid any default or restructuring of sovereign debt over the next few years. This is also the middle week of the second-quarter earnings season. At the start of July, S&P500 operating earnings were expected to reach $19.68 in the second quarter, only up modestly from $19.38 in the first quarter. However, as of last Thursday, 72% of firms reporting had beaten estimated earnings and 66% had beaten estimated revenues. Adding these numbers to estimates for those yet to report generates an earnings number of $20.34, but if the upside surprises keep coming, earnings should surpass $20.50 by the time the season ends. For investors, this is worth considering. While the outlook is, in Ben Bernanke's words, unusually uncertain, this much maligned economic expansion has proven capable of generating a sharp rebound in corporate profits while some risks, such as the European sovereign debt threat, seem to be fading. Meanwhile, both stock prices and Treasury yields seem too low if even a moderate economic expansion continues. For individual investors, while the first chapter of recovery did contain some scary parts, the story should get less frightening as future chapters unfold. ***** ***** ***** Monday, July 26th New Home Sales Forecast Last Sales, mils, ann rate 0.311 0.300 Inventories, mils 0.204 0.213 Tuesday, July 27th Consumer Confidence Forecast Last Index Level 51.0 52.9 Wednesday, July 28th Durable Goods Orders Forecast Last Total, %ch - 1.0% - 0.6% Ex. Transportation, %ch 1.1% 1.6% Thursday, July 29th Jobless Claims Forecast Last Initial Claims, 000's 450 464 Continued Claims, 000's 4,450 4,487 Friday, July 30th Q2 GDP First Est Last Real GDP, %ch, ann rate 2.2% 2.7% GDP Deflator, %ch, ann rate 0.1% 1.1% Chicago NAPM Survey Forecast Last Index Level 54.8 59.1 Employment Cost Index Forecast Last Comp, %ch 0.5% 0.6% Wages, %ch 0.4% 0.4% Benefits, %ch 0.7% 1.1% Consumer Sentiment Final Prelim Index Level 68.5 66.5