By Joseph A. Harrison, CFA, Partner

Positive investment returns during the third quarter helped the healing process of the preceding three years. Moderate gains afforded investors time to adjust to an improving environment and assess the ongoing stream of economic data rationally and with a growing sense of confidence. The economic recovery has been slow, but steady. The upward revision to second quarter GDP was a confirmation of the recovery and lent substance to the positive economic data reported throughout the quarter.

Positive signs

Earnings reports were positive overall, with most companies meeting or exceeding estimates. Cost controls, a weaker dollar, strengthening real final demand, and lower interest rates were all contributing factors. The inventory-to-sales ratio touched historically low levels, indicating that strength from inventory demand remains for the future. Consumer demand remained strong despite an increase in interest rates. Chain store sales recorded solid gains and auto sales, up 10% in August, surprised everyone. Housing also remained strong, despite rising mortgage rates. The growth in real disposable income is the principal source of support to the consumer. Tax cuts and lower debt-service costs after the recent refinancing period were more than enough to offset continuing weakness in the labor market and seasonally higher energy costs.

Confidence improves

Capital spending and hiring usually lag in an economic recovery. Orders for durable goods and data from the Institute for Supply Management suggested that corporations are overcoming uncertainty and were more willing to invest. Many company managements we spoke with indicated an upward pace in their business—especially in the manufacturing sector. Improved profits, cash flow, and new tax incentives for capital spending supported an improvement in business confidence.

With an improving business spending climate for both capital goods and inventory augmenting consumer spending, the employment picture should begin to improve. Although improved technology and capital spending incentives allow production to be met with fewer workers, eventually demand will be great enough to offset the inertia most companies have when faced with hiring additional workers.

The near term outlook?

Productivity and increasing demand should provide leverage for earnings growth, and improved corporate governance should provide improved earnings quality. The equity market recovery of the last six months may indeed be a forerunner to that picture. In turn, sustainable economic growth and improving incomes and employment should support sustainable positive investment returns.

Joe Harrison’s astute knowledge about the nation’s business and keen understanding of economic trends have helped him manage client portfolios that produced enviable results. If you are not currently a client at our firm, we invite you to contact Joe Harrison to learn the benefits that a managed account relationship with our firm offers you. He can be reached at (216) 830-1131 or e-mail: jah@mimllc.com