Revisionist History

We got two bits of economic revision from the official government sources yesterday, one of them good and one of them bad. The bad news was that the estimate of GDP for the second quarter slipped from the previous reading of 1.7 percent all the way down to 1.3 percent. The slippage was attributed to weaker consumer spending and reduced farm inventories, which were hit hard by the drought.

On the other hand, the employment numbers for the past year got revised upward. After carefully reviewing state unemployment rolls, the Bureau of Labor Statistics announced that an additional 386,000 jobs had been created between April 2011 and March 2012. The Labor Department reviews the state records once a year to check the accuracy of its already-released figures.

The lower job-creation numbers we've seen over the past couple of months remain, to this point, unchanged. Also unchanged is the official unemployment rate, which is derived using somewhat different methods. It remains at 8.1 percent.

QE3 and Inflation

One of the big fears of a program like the Federal Reserve's recently announced third round of quantitative easing is that pumping all that money into the economy will stoke fears of inflation. And indeed, immediately after Ben Bernanke announced the Fed's latest bond-buying effort, there was a bit of inflation frenzy. The spread between the ten-year Treasury bond and the ten-year Treasury Inflation-Protected Security (TIPS) - which should reflect what investors expect inflation to average over the next ten years - was at 2.38 percentage points before Bernanke's announcement.

After the announcement, though, the TIPS spread jumped to 2.67 percentage points. That's the highest that the spread had been since way back in May 2006, and the trajectory of the growth was a bit frightening.

But since that initial burst, the inflation spread has been declining. As of yesterday, the TIPS spread was back to just 2.44 percentage points. At this rate, before long it could be back to the pre-QE3 level.

Consumer Confidence Inches Upward

There was a significant jump in the consumer confidence figures released yesterday, as the Consumer Confidence Index reached its highest level in seven months. Nearly every aspect of the index showed improving conditions, a marked change from August, when the confidence reading fell.

At the same time, a closer look at the numbers shows that this economy is still a long way from where consumers would like it to be. The number of people saying that jobs are plentiful rose - but still just 8.3 percent of the respondents said that, up from 7.2 percent in August. Likewise, the percentage of people saying that jobs are hard to get also declined - from 40.6 percent in August to 39.9 percent in September.

At least the trends are all in the right direction. And there was another, longer-ranging piece of good news regarding America's consumer habits: The Labor Department reported that the average American household spent $49,705 in 2011, up 3.3 percent from 2010 and the highest level we've seen since 2008.

Slow and Steady Wins the Race

"Boring" is a pretty underrated virtue for a stock market. What we've seen in the past couple of months from the Dow Jones industrial average may have been pretty dull, but it's also been pretty good for investors. According to information compiled by the Bespoke Investment Group, yesterday marked the 63rd trading day since the Dow has seen a daily decline of greater than 1 percent.

That's a nice little sustained run, dating back to June 25, or three full months of calendar time. We've only had 16 such quarters in which the Dow has avoided a 1 percent daily loss since 1900, according to data from Sundial Capital Research.

And the good news is, Sundial also found that such consistent performance tended to lead to more good news. After each of those quarters without a single significant daily drop, the Dow showed positive returns for the ensuing six months, with an average gain of 6 percent.

Taking the Long View

This has been a very good year for the stock markets, with the S&P 500 index returning around 16 percent so far for 2012. The performance has been strong enough that the ten-year returns for that index are now up to 6.5 percent (including reinvested dividends). Even with the precipitous plunge we had in 2008-2009, the long-term averages for equities are looking very good.

Even so, the bond market has been considerably stronger. According to figures compiled by Morningstar, corporate bonds have returned 8.4 percent annually over the past ten years. Even U.S. Treasury bonds, which have had historically low yields lately, have returned more than the S&P 500 over that decade.

Does that mean bonds are now likely to offer higher returns than stocks? Of course not; past performance, as they say, is no guarantee of future results. And without a chasm like we saw in the stock market when the financial sector collapsed, equity returns could very well be higher over the next ten years than they were over the past ten.

Small Cap Troubles?

One of the recent bright spots in the market recently has been small-cap stocks. The benchmark Russell 2000 index is up 13 percent since June, a return that’s better than the mark put up by either the Dow Jones Industrial Average or the S&P 500. But will it last?

With earnings running so high lately, the market as a whole is still fairly low-priced according to historic norms. But small-cap stocks are less of a bargain than larger ones. According to data compiled by S&P Capital IQ, the S&P 500 collectively is trading at a price-to-earnings ratio of about 14, as opposed to a historical median of 18.2 since 1995, a difference of about 30 percent. The S&P 600, though, has a P/E of 19.9 as opposed to a historical median P/E over that same time frame of 21.4. For the small-cap index, then, the current difference is just 7.5 percent. 

What that means is that small-cap stocks are much closer to their historic valuations than larger stocks. It doesn't necessarily mean large caps will show more growth in the near future, but it is a point in the big stocks' favor.

What's Going to Turn Stock Funds Around?

We’ve mentioned at several points this year that domestic stock funds have been losing assets at a horrific rate lately; they saw another $14.2 billion in net outflows in the month of August. The mutual fund news source Ignites has asked its readership a simple question: When will this trend reverse? 

This question has implications not only for the mutual fund industry but for the wider stock market as well. More money flowing into the market, all other things being equal, would be good for stock prices.

The answers were fairly mixed. Roughly 31 percent, the highest figure for any response, said that steady employment and income growth is what will bring investors back to equities. Another 27 percent said the most important thing was government progress on taxes, spending and the deficit. Other answers getting some solid support include rising interest rates and several quarters of strong GDP growth.