However, even though demand has improved, companies continue to squeeze more out of existing workers as evidenced by third quarter productivity growth of 1.9%. We don't believe this can continue too much longer before employers add to payrolls to meet increased demand as we head into 2011.
Despite the continued weakness in the labor market, retailers recently reported largely better-than-expected results and sounded broadly optimistic about the holiday season. And they may have good reason, as ISI research reports that holiday sales have an 89% correlation with the performance of the S&P 500Ā® index.
Will confidence return?
It is this apparent increase in business and consumer confidence that the Fed is hoping to stoke as it embarks on another round of quantitative easing.
While we still don't believe another round was needed, it is clear that the Fed is committed to doing whatever is necessary to foster more robust economic growth and avoid the possibility of deflation. This commitment should be a positive for many asset classes, at least in the near term.
Unfortunately, QE2 may not help the housing market in a meaningful way. During the last round of quantitative easing, mortgage rates stayed relatively steady. It's unlikely there are many buyers out there who are waiting for rates to go even lower before stepping in.
We are hopeful that the recent technical legal questions surrounding foreclosure paperwork get resolved quickly so confidence among buyers of those properties can return. We remain convinced that housing is likely bouncing along the bottom, with not a lot of further downside likely, but a sharp, quick rebound seems unlikely, as well.
We are also concerned about the unintended consequences of the Fed's actions. With more dollars flooding the economy, the US currency is likely to remain under pressure, although we would expect to see some periods of strength as traders take profits.
While this is typically beneficial to exports, they make up only about 12% of our economy. But the weakening dollar also increases protectionist rhetoric and pushes commodity prices higher, which hurts the 70% of the economy that is consumer-driven.
We also need to see confidence return to small business as that's where the majority of job growth occurs. The recent National Association of Independent Businesses (NFIB) survey showed an improved reading, but it remains in recessionary territory.
Confidence Improving, but Still Has a Ways to Go
Click to enlarge
Source: FactSet and the National Federation of Independent Business, as of November 9, 2010.
The recent election results should help as it's likely some of the more potentially damaging regulatory proposals will be tabled, while it is also likely that most or all of the Bush tax cuts will be extendedāproviding some certainty for businesses as they plan their 2011 expenditures.
Getting clarity on taxes within the lame duck session would be ideal for confidence. If clarity is delayed until the new Congress is sworn in, consumers and business would see their paychecks and earnings reduced for a month or two, which will affect spending.
President Obama's recent statement that he's willing to consider extending all tax cuts provides hope that the lame duck session can produce the extension that we believe is necessary to sustain the recent economic momentum.
Currency consternation
The decline in the value of the dollar is due, in large part, to the Fed's infusion of dollars via QE2 that has dominated international market action.
Examples include Japan: Somewhat in resignation to the inability to weaken the yen, the finance minister is encouraging its companies to use yen strength to purchase foreign assets.
Additionally, carmaker BMW is relocating a facility to the United States to take advantage of lower manufacturing costs and high skill sets of US workers, and reduced transportation costs to the US market. We believe this trend of more domestic production is in its early stages given the narrower wage and real estate cost differentials.
Meanwhile, other nations are fighting the dollar's decline. No fewer than eight countries are actively instituting currency controls through some form or another. Brazil has called for a reduction in the dollar's role in international trade, and China said the United States isn't living up to its responsibility as an issuer of a global reserve currency and its obligation to stabilize capital markets by pursuing QE2.
