David Kelly: The views of Wyoming vs. Wall Street

The following is the market commentary of David Kelly, chief market strategist at JPMorgan Funds, for the week of August 30. In his widely-anticipated speech in Jackson Hole, Wyoming last Friday, Fed Chairman Ben Bernanke stated that the Fed was “…prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.” However, in the same speech, he reviewed the current state of the U.S. economy sector by sector and concluded that he expected “…the economy to continue to expand in the second half of this year, albeit at a relatively modest pace…” and that “…preconditions for a pickup in growth in 2011 appear to remain in place.” Judging from the current pricing of the stock and bond markets, investors do not share even this limited optimism. Numbers out this week will help clarify whether the view from Wyoming is clearer than the view from Wall Street. Monday's numbers on Personal Income and Spending should show some decent gains in July, setting the stage for roughly 2% real consumer spending growth for the quarter. Tuesday's Chicago Purchasing Managers' Survey is likely to show a sharp decline following a surprisingly strong July reading while Consumer Confidence could show exactly the opposite pattern, bouncing back from a very low level in July. Vehicle Sales due out on Wednesday will help shape impressions of consumer spending in April and industry reports suggest that they will be about flat at a still deeply-recessionary level. The national ISM Manufacturing Survey, due out on the same day, should see a decline based on regional surveys and markets may be quite sensitive to the extent of the decline. Thursday's report on Pending Home Sales could go a long way to clarify whether July's abysmal housing readings do really represent a trough in the wake of the expiration of the home-buyer tax credit. However, important as this is, weekly Jobless Claims will probably garner more attention, as analysts will want to see if last week's decline in claims represents a true reversal of the summer's most troubling economic trend. Jobless Claims will also be important as a way of teeing up the August Jobs report, due out on Friday. The single most important data point will be the growth in private sector jobs. Models suggest that this number could be very low and perhaps negative. However, the margin of error in forecasting this number on the part of economists or even tabulating it on the part of government statisticians far exceeds the range over which Wall Street might be indifferent. Because of this, markets are likely to react strongly to this number either way. However, while numbers this week will help calibrate estimates of economic growth, they are very unlikely to justify the extremes in valuation currently seen in U.S. financial markets. The gap between BAA corporate bond yields and the earnings yield on the S&P500 is at its highest level in 30 years. Investors, to an extraordinary degree, appear willing to overpay for bonds rather than underpay for stocks. This attitude could well prove expensive if the view from Wyoming turns out to be more accurate than the view from Wall Street.