Economy: Looking for Hope in the Holidays

The recovery still hasn't found firm purchase. As market watchers and economists look for signs of what’s ahead, they’re now scrutinizing signs of uncertain demand—including third-quarter results from retailers that were driven by cost-cutting and a murky holiday sales outlook.

At the end of the third-quarter earnings season, the pace and durability of an economic pickup remained open to question, though LPL Financial chief economist Jeffrey Kleintop found reason to be optimistic.

"The aggressive cost cutting in corporate America has led to a profit-driven economic recovery," he wrote Nov. 16. "As earnings rebound, businesses are looking to reinvest in growth. We expect that this renewed pace of business spending will lead to job growth by early next year, helping to sustain the recovery."

Ed Yardeni, founder of Yardeni Research, certainly liked what he saw, taking in the six-week period of corporate profit news and seeing room for more improvement. The S&P 500 rose to a new bull market high of 1109, up 66.6% since the March 6 intraday low of 666, he noted Thursday. "The stock market rally may turn into a bubble, but it isn’t overvalued right now,” Yardeni wrote.

But the holiday shopping season is a period when the markets and the economy do move in closer step, and if consumers aren't buying, using credit or going back to work, that could make for meager results for stockholders and gift openers.

Marshal Cohen, chief industry analyst at the NPD Group, a market research firm, said wallets won't be clamped shut, but they won't be opened with abandon, either. The group said 30% of consumers surveyed told NPD they “plan to spend less” this holiday.

“All of our indications suggest that consumers will shop but be more cautious in their approach,” Cohen wrote Nov. 16. “The study’s results show consumers will be doing their homework a bit more carefully this year.” This year’s holiday study reports that almost half of consumers said they would comparison shop before they buy. “That 45% is at a five-year high,” he wrote.

Ned Davis, president and senior investment strategist of Ned Davis Research, said market conditions would likely be cause for optimism as shoppers ponder purchases. The recent rally, though it faltered a bit last week, is still encouraging, as are other indicators, he wrote Tuesday.

"A strong tape, corporate yields still falling, sentiment not showing extreme optimism, and low inflation are a pretty bullish signal,” Davis said, adding that “at this point in time we don’t have any evidence that the cyclical bull market is over.”

But Societe Generale chief U.S. economist Stephen Gallagher wrote Tuesday that some structural components of a sustainable economic recovery are slowing down, and that could contribute to a more herky-jerky path to renewed growth than a straight-up speedy recovery. After three months of strong gains in industrial output, the pace of growth slowed to just 0.1% in October from the previous month. He said the slowdown is driven largely by auto production, which contracted by 1.7% over that period -- a reasonable response to a September pullback in auto sales after the expiration of the cash-for-clunkers program.

In explaining the slowdown for autos and industrial production generally, Gallagher found reason to be optimistic about unemployment as well. Auto sales have resumed their climb in October and are on track to post another sequential increase in November, which should trigger a resumption of production gains in the auto sector.

"More broadly, we still see a substantial gap between production and the current levels of demand. The relationship between industrial production and retail sales suggests that that gap could be as large at 6%. Even with flat sales, further production gains will be required to close the gap and stop inventory depletion," he wrote Tuesday.

That means, eventually, maybe sooner rather than later, the economy should support ongoing production gains – and GDP gains – in the next few quarters. "Can businesses continue to ramp production without extending hours? It is doubtful," Gallagher wrote. "Productivity gains are already running substantially above trend and the pace will be difficult to sustain. We see the production gains as ultimately triggering modest job gains in manufacturing."

And when people go back to work and start spending money, there will be something substantial for markets to celebrate.