Is the Dow Sniffing A Big Slowdown?

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Notwithstanding Thursday’s slight improvement in weekly jobless claims, it’s  been a pretty rough summer on the economic front. On Wednesday we learned that durable goods orders rose a tepid 0.3% for the month of July, less than economists had expected. On Tuesday, existing home sales tumbled 27%, much more than economists had expected, and the Dow re-entered the sub-10,000 sphere briefly on Wednesday morning. What’s going on with this recovery, and also with this recovery market’?  The stock market’s recent weakness is not due to  Tuesday’s horrible housing report nor Wednesday’s weak numbers on durable goods orders. Rather it’s a reflection of the sum total of what we are seeing, which is an economy that is losing momentum. That’s not  so much of a problem–i.e., there’s still low probability of a return to recession– except for the fact that most economists are not expecting a sharp slowdown, nor are securities analysts. But investors seem to be getting the drift, which is why August is shaping up to be a down month for the market.

It’s an especially interesting juncture at this point because forecasts from both economists and analysts are still pretty bullish. These two groups are closely linked because analysts usually incorporate their firm’s economic forecast into earnings projections for companies.It also means that once economists start lowering their growth forecasts, analysts will soon follow.

The Blue Chip Economics Indicators consenus of private economists points to  2.7% growth in the final quarter of 2010 and a healthy 3% rate of growth for 2011.  Analysts are upbeat too. Zacks Investment Research, which collects data on analysts’ forecasts, notes that the Street is forecasting S&P 500 earnings to rise 41.6% in 2010 and another 15.2% in 2011. All this is pretty bullish thinking, but increasingly at odds with the economic data.

Goldman Sachs chief economist Jan Hatzius is out this week urging his fellow forecasters to start trimming their forecasts. He argues that the big drivers of  growth over the past 12 months have been fiscal stimulus as well as a corporate swing from inventory liquidation to a period of accumulation. The inventory swing alone, he figures, has added 1.9 percentage points to real GDP growth, while beefed up government spending–the stimulus– has added a little more than  one percentage point to final demand growth. He’s worried that with those two factors receding, there will be a major air pocket for the economy. Just to get to 1.5%% growth going forward, he says, we will need to see healthy 1% growth in final demand…not a given with everything slowing down.

As forecasts converge with reality (i.e., weakness in durable goods, housing, the weak labor market) investors will likely become more cautious on stocks. Mary Ann Bartels, the chief technical analyst over at BofA Merrill Lynch, notes that the stock market leadership  from tech and financial is “waning,” and without  such leadership forward progress will be hard to come by.

The big market news on Wednesday was that the Dow had dipped below 10,000. While this is nothing to ignore it’s not the number to focus on. That would be the S&P 500, which closed Wednesday around 1055. Bartels’ analysis leads her to worry about 1010 which was the S&P low reached on July 2nd.  Any break below that low, Bartels says, and we could be in for a deeper dive. Technical analysis has its limits but it’s pretty good at spotting market turning points, and right now it’s flashing yellow.