The Growth Debate Continues

Stocks will likely find it hard to sustain Tuesday’s broad gains as the reality of weak domestic growth and the Greek debt issue takes center stage – all over again. The key report this morning relevant to the domestic growth question was the weaker than expected June Empire State survey. This report is a proxy for the health of the manufacturing sector in the state of New York.

The recent deceleration in the manufacturing sector, which had thus far been one of the best performing aspects of the economic recovery, has been attributed to temporary Japan-related factors. Given that, we would expect the clouds to start lifting any time now. Today’s Empire State survey didn’t provide any such evidence. May be the Industrial Production report later today or the Philly Fed survery coming out tomorrrow may help on that score. But more likely, we will have to wait for next month’s data to address this issue

The inline May CPI report is further evidence, following Tuesday’s PPI read, that the issue with the U.S. economy is not inflation, but growth. The recent pullback in commodity prices has vindicated the Fed’s view that the pricing pressures that we started seeing earlier this year were transitory in nature. But the growth and inflation issues are related given the Fed’s dual mandate. The idea is that a less-than-benign inflation reading limits the Fed’s ability to provide further stimulus to the economy. In that context, today’s CPI report is not friendly to further Fed stimulus.

As mentioned at the top, Greece is again hogging the headlines today after EU officials failed to agree on what do with it. There are two views within the EU on how to deal with the Greek question. One view, led by Germany, favors a plan that amounts to a default by the Greeks (they never use the ‘default’ word, it is called ‘reprofiling’), where the lenders would ‘voluntarily’ extend the maturities on Greek debt.

The other group, led by France and the European Central Bank, favors extending the Greeks another bailout. You would be perfectly justified in calling the second plan the ‘kicking-the-can-down-the-road’ alternative.

The complication is that a large number of European banks have exposure to Greek debt. So a default (or reprofiling) would force write-downs on a number of banks that had only recently recapitalized. A rating agency’s warning to three major French banks this morning primarily reflects their Greek exposure. Whatever is decided in the coming days, one thing is certain. The Greek problem is not going away anytime soon.

On a positive note, the market’s excitement for internet IPOs has not waned even as overall market sentiment has soured. Pandora (P), the internet radio site, starts trading today following a successful IPO Tuesday evening. Pandora’s success comes after the enthusiastic reception that LinkedIn (LNKD) received in the recent past. This adds to the excitement for Facebook and Groupon, which are expected to eventually come to the market.

About Sheraz Mian 45 Articles

Affiliation: Zacks Investment Research

Sheraz Mian is the Director of Research for Zacks.com.

Visit: Zacks Investment Research

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