This week’s releases offered data that portrayed a softer economic environment, particularly in the United States. Financial conditions improved; spreads narrowed and the Bloomberg Index snugged higher to -0.25 standard deviations. Uncharacteristically, both equity and bond prices were higher on the week. The U.S. dollar fell. Oil prices rose a couple of bucks to just under $81 per barrel; gold rose almost $24 to $1,205 per ounce.


July’s soft U.S. employment report (see below) renewed consideration of the phrase “new normal,” which was attributed to PIMCO’s Bill Gross and repeated by TV personalities on CNBC and elsewhere. What does “new normal” mean? The connotation of normal is similar to a mean or average; the phrase suggests that this is what we might expect with deviations around the normal, with mean reversion bringing us back to the norm. Normal is the point around which the economic activity will oscillate. The U.S. economy has seen anemic growth, little improvement in employment, stagnant housing, low bond yields, and meager stock returns; corporate earnings have been one of the few bright spots.

The “new normal” is an accurate description of the current environment, but it may not be the expected mean out in the distant future. The economy is like an evolving organism. New technologies and political changes create opportunities and challenges. Just as the shock of the financial crisis created the current environment, events in the future may cause acceleration and deceleration in economic activity. Taken too literally, the concept of “new normal” denies unforeseen changes that have always taken place and will do so in the future.

In the 1970s and ’80s the unemployment rate in the United States was well above 5 percent, peaking at 10.8 percent in the fall of 1982. At that time, the conventional wisdom was that if the rate ever got below 5 percent the labor shortage would unleash significant inflationary pressures. “Normal” unemployment was well above 5 percent. Unemployment dropped well below 5 percent in the second half of the 1990s, reaching a low of 3.8 percent in April of 2000. Yet inflation remained well contained with the CPI averaging .2 percent per month (less than 2.5 percent per year) since 1994.

The point is that we typically see the future in the context of the current environment. “Normal” changes over time. This environment is not “normal;” it is merely the current environment. We don’t see anything that will change the current environment and so it is easy to characterize the current environment as the “new normal.” Arguments that the higher regulations, increased costs of government and lower leverage requirements will dampen future growth rates are reasonable.

Supporting the current assessment of the economy in interviews this weekend were two former Treasury secretaries, Paul O’Neill and Robert Rubin, who stated that the economy will improve slowly and that further stimulus is not needed and may not be effective. So, get used to it! Change will come slowly, too slowly for those that are unemployed and those that want to get re-elected in 2010 and beyond. And so, as O’Neil and Rubin indicated, patience is required.

Economic releases

Total non-farm payrolls (red) fell -131,000 in July with the release of more census workers, which inflated the number of workers added to over 400,000 earlier this year; June’s NFP total was revised 100k lower to -221,000. Private payroll, which excludes the hiring by the U.S. government rose 71,000; this is a better measure of the state of the recovery than the total NFP, and was less than forecast by economists; June’s numbers were revised 50k lower to 31,000. Manufacturing employment (blue) rose 36,000. The four-week average of initial jobless claims (green) inched higher to 458,500 in July.

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Sources: Bloomberg LP

In other U.S. employment news, July’s average hourly earnings increased +0.2 percent while the average hours ticked up to 34.2. Also concerning, initial jobless claims increased to 479,000 the final week of July. The unemployment rate remained at 9.5 percent, many have worried that it could go higher again before it falls below 9.0 percent.

Other economic releases

The purchasing managers’ indices for July were little changed and remained in the expansion zone above 50. U.S. manufacturing and services were 55.5 and 54.3 respectively; euro-zone manufacturing and services were 56.7 and 55.8 respectively; France’s were 53.9 and 61.1 respectively; Germany’s were 61.2 and 56.5 respectively; UK’s were 57.3 and 53.1 respectively. China’s manufacturing dropped to 49.2 while its services index rose to 56.3.

In the United States, personal income and spending were both flat in June while previous month’s data were revised slightly lower. Construction spending was only a tick higher in June, but prior months were also revised lower. June’s factory orders fell -1.2 percent in June; prior months were also revised lower. Domestic and total vehicle sales in the United States were a touch better than expected in July at 8.94 and 11.56 million seasonally adjusted annual rate respectively.

Canada’s unemployment rate increased a tick to 8.0 percent in July.

Factory orders in Germany rose 3.2 percent, but industrial production fell -0.6 percent in June. UK’s industrial production fell -0.5 percent but the manufacturing production rose +0.3 percent in June. The Bank of England met and agreed to keep its stimulus in place, making no change in the target bond holdings of 200 million pounds or its interest rate of 0.50 percent, despite some dissension among the policy makers.

Equity markets

Equity markets were higher across the globe. Meanwhile, earnings reports continued to have the more-than-usual upside surprise bias with over 76 percent of the S+P 500 companies reporting positive surprises and 15 percent reporting negative surprises this quarter.

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Bond markets

This week government bond markets also rallied with the U.S. two-year reaching a new record low, below 0.50 percent. Softer economic data has convinced bond investors that the U.S. Fed is on hold for some time.

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The dollar fell against the Asian and European currencies below as further evidence of an economic soft patch unfolded in the United States.


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Economic sectors

All economic sectors generated positive returns, but the small cap sector generated negative returns for the week. Health care companies and large-cap growth had the best returns while financials and small cap growth companies had the worst returns.


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