July 27, 2011

Markets Spooked by Two Dreary Signals: Debt, Durables

Stalled debt talks and durable goods report signal rough times ahead; robust gains in trucking may be cold comfort

U.S. markets fell sharply on Wednesday as two key indicators projected a dim view of the near-term future of the U.S. economy.

The Commerce Department's durable goods report for June showed a monthly decline of 2.1%, more than erasing May’s 1.9% gain and joined with April’s 2.5% decline—marking a slowdown trend upsetting to Wall Street traders who look to durable sales as a guide to future economic activity.

The Nasdaq closed down 2.65%. The rout on the tech-heavy index surely reflects the fact its constituent stocks sell durable goods, particularly capital equipment. For example, in afternoon trading, Tellabs (TLAB), which makes networking equipment, was down nearly 8%; Cisco (CSCO), a larger networking equipment company, was down 3%.

The S&P 500 fell 2.03% and the Dow Jones Industrial Index was off 1.59%.

Nearly half the volume of new orders of durables includes economically sensitive capital goods, which have further uses in manufacturing and production. New orders for nondefense capital goods fell even harder in June, declining 4.1%; (the less important defense-related capital goods new orders suffered a similar decline–3.9% in June).

The fall in new orders of durables, and especially capital goods, can be seen as a sign of an economic slowdown in the months ahead. Year-to-date shipments and new orders reflecting economic recovery in the first quarter are still quite positive, however, up 7.6% and 9.4%, respectively.

Longer-term, the impasse in Washington over a deal to raise the debt ceiling and avoid default may also be spooking Wall Street, where a game of political chicken over starkly competing budgetary views has shown the two parties are so at odds that obligations to foreign creditors are being effectively held hostage.

Amid the negative news and falling stocks, the American Trucking Association reported a sharp rise in trucking tonnage for June—6.8% over the previous year, and 2.8% over May results. The volume of goods hauled is a key barometer of economic activity, but unlike durable goods it is rearward looking.

In releasing the data Tuesday afternoon, ATA’s chief economist, Bob Costello, said in a statement: “If manufacturing continues to grow stronger than GDP, I fully expect truck freight to do the same.”

For the near-term at least, Wednesday's durable goods report seems to suggest weakness in manufacturing activity ahead. And that’s why Wednesday’s market losses were so steep.

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