Recent positive news gives us hope

Growth in service sector: The U.S. service sector grew for a second straight month in October, but at a slower pace than in September. The Institute for Supply Management said its service index dipped to 50.6 in October, from 50.9 in September. Any reading above 50 signals growth. The index tracks the country's hospitals, retailers, financial services companies and truckers.

Growth in manufacturing: The ISM also reported that its gauge of manufacturing activity grew in October at the fastest pace in more than three years - faster than expected. The ISM index rose to 55.7 in October, the third straight reading above 50, which signals growth. Businesses' replenishing stockpiles, higher demand for American exports and support from the government's $787 billion stimulus program were said to be behind the numbers.

Factory orders rose: The Commerce Department said orders to U.S. factories rebounded 0.9% in September, helped by strength in autos, heavy machinery and military aircraft. The fifth increase in six months bolstered hopes that a revival in manufacturing will help support an overall economic recovery. The gain was thought to be related to a need to stabilize inventories after huge liquidation in the first part of the year. The worry is that if consumer spending falters in coming months, orders will drop again.

Auto sales gained some traction: After a nearly two-year industry slump, the U.S. auto sector is showing signs of recovery with major automakers reporting higher sales for the month of October, lead by rising customer demand for new cars and crossover utility vehicles. GM's U.S. sales rose 4.7% from October 2008, while Detroit rival Ford Motor Co. showed a 3% gain. Japanese rival Toyota Motor Corp. said its sales edged up less than 1%. (Chrysler's sales fell 30%, though they improved from September.) The biggest winners were Hyundai, based in South Korea, whose sales jumped an astonishing 49%, due largely to its fuel-efficient Elantra sedan, and Japanese automaker Subaru, with a 41% gain from strong sales of its Outback and Forester models. Automakers considered October a test of the auto market, after the government's "Cash for Clunkers" sparked a huge demand over the summer, followed by a natural drop in September after the program ended. This news was a positive surprise.

Retail sales beat expectations: Same-store sales at many retailers were stronger than expected in September. U.S. retailers, including Macy's Inc. and Abercrombie & Fitch, surprised Wall Street with better-than-expected September sales. To some, this suggested that shoppers were loosening purse strings before the all-important holiday season. Sales of clothing for back-to-school needs fueled some performance, as consumers were said to be dipping their toes back into the discretionary-spending waters. Some 16 of 24 retailers beat Wall Street estimates. Limited (1%) and Children's Place (4%) were among those retailers that posted same-store sales increases, and beat expectations. Even those that showed same-store declines did so more moderately than expected. For example, Macy's sales fell 2.3% -- half as much as analysts anticipated. Teen apparel retailer Abercrombie saw same-store sales drop 18%, but that was better than the 21% decline predicted by analysts. Aeropostale Inc., American Eagle Outfitters Inc. and Gymboree Corp. raised their quarterly profit forecasts.

Existing home sales are looking up: the National Association of Realtors said the volume of signed contracts to buy previously occupied homes rose 6.1% in September to a reading of 110.1 - the eighth straight monthly gain. That's the highest level since December 2006. And it's more than 21% above a year ago. The improvement has been aided by federal intervention to lower mortgage rates and bring more buyers into the market. For example, the contracts to buy homes rose as buyers scrambled to qualify for a tax credit for first-time buyers. Lawrence Yun, chief economist of the National Association of Realtors, says, "Much of the momentum is from people responding to the first-time buyer tax credit."  New home sales constitute only about 10% of all home sales. The rest -- the biggest portion -- are made up of existing home sales.

Congress is focused on housing: The Senate just voted to extend the $8,000 tax credit for first-time buyers to contracts signed by April 30, 2010 and closed by June 30, 2010. You may recall we suggested in a prior article that this extension was crucial. The bill also created a $6,500 credit for those who buy a home after owning one for the last five years. The current credit defines a first-time homebuyer as someone who has not owned a residence within the past three years. Additionally, Congress passed a stopgap measure that will keep in place for now the significantly higher loan limits for federally backed mortgage loans. In the U.S., housing (and everything associated with it) accounts for 40% of GDP, so it stands to reason that if you stimulate housing the economy will follow.

Economy is expanding: The overall economy, as measured by the gross domestic product, expanded at a 3.5% rate in the July-September quarter, offering evidence that the longest recession since the 1930s was ending. David Wyss, chief economist at Standard & Poor's in New York, said he expects GDP growth to slow to around 1.7% in the current quarter and to remain sluggish in the first half of next year. Other economists are more optimistic, with some forecasting that GDP growth could come in around 3% in the current quarter.

Some encouraging signs from the job market: The number of new unemployment benefit claimants has fallen each week for the past month, and the number of people on continuing benefits fell to its lowest level in half a year. On Wednesday, the Senate voted unanimously to lengthen unemployment benefits by up to 20 weeks. The bill would extend jobless benefits in all states by 14 weeks, with another six weeks added for those who live in states with unemployment greater than 8.5%. The proposal, which needs to pass the House, would be funded by extending a longstanding federal unemployment tax on employers through 2011.The measure would apply to those whose benefits will run out by Dec. 31, which is nearly two million people, according to Senate estimates. Those whose checks have already stopped would be able to reapply for another round.

The market has rallied: A year ago in October 2008, the S&P 500 was at 839. A year later (Oct. 2009), it was at 1,101. The S&P 500 is considered a bellwether for the American economy

Still wary of ongoing headwinds

The housing market is still fragile: The waxing and waning of the housing market can drive people to distraction from one week or one month to the next. For example, home resales dipped unexpectedly by 2.7% in August, after a four-month streak of gains. "We suspect it is just a temporary blip in the improving trend rather than a sign of renewed weakness," wrote Paul Dales, U.S. economist at Capital Economics. "There is strength in the market and we will see stronger sales through November," said Patrick Newport, an economist at IHS Global Insight. Nationwide sales are up more than 10% from their bottom in January, but are still down nearly 30% from their peak nearly four years ago. Earlier, home prices rose in July, a trend that helped to ease the foreclosure crisis, and that shows that recession-weary consumers are still willing to take advantage of a deal. Prices had declined for three years before turning around in June. Now, mortgage rates around 5%, the tax credit for new owners and some low-priced foreclosures have savvy buyers on the lookout for housing bargains. A rebound for home prices is critical, because homes are typically a consumer's largest asset and rising prices make them feel wealthier and more confident to spend money. Consumer spending is the most important engine for economic growth. Both of these factors will help buttress the banking sector as well.

Trade disputes with China remain: Last month we advised that the ongoing conflict between the World Trade Organization and China was a crucial fight for the Obama Administration, and a test of his leadership mettle. Obama rose to it, and levied a 35% import tax on Chinese tire imports, which prompted China to formally launch a case with the WTO challenging that decision. Beijing estimates the sanctions will cost it $1 billion in revenues and will affect 100,000 jobs there. In a tit for tat, Beijing has publicly mused that it is likely to target American chicken and automotive exports in retaliation. While Obama's move may have been done to rectify trade disputes, it has had an ironic, but intended, consequence in that some of the big U.S. tire companies have moved tire production to China in recent years and now they are forced to handle the reality that their own imported tires will cost U.S. consumers an extra 35%. The U.S. Commerce Department also announced it was levying duties on steel pipe from China. The Administration also announced that tariffs are being imposed on solar energy products, which is the declared new No. 1 growth industry in China. It looks like Obama wants to reserve much of the growth in demand for solar and wind industry products for U.S. factories. The tools that President Obama is using are within America's rights under WTO agreements. Former Presidents Bush and Clinton refused to exercise these rights as more and more jobs were exported. Our complicated economic relationship with China has even spawned a new word - Chimerica, a noun defined as the interrelated elements of the economies of China and America, particularly the Chinese supply of credit to America and the American purchase of cheap Chinese goods. In any event, the unabated march of jobs to China is at least now a point to negotiate and fight back on, not a foregone conclusion.

The national mood is cautious: Consumers remain wary of spending as jobs are scarce, lending is tight and government stimulus programs end. Holiday spending could be further dampened by consumer aversion to debt. Total U.S. consumer credit posted a deeper-than-expected drop in August, suggesting consumers are opting to cut their debt rather than spend. Can these hard-won economic gains be sustained if consumers don't spend?

Jobs are a huge concern: Unemployment is the psychological hot-button in the recovery. Unemployment is likely to remain at current levels for a while as companies don't hire until after business has picked up. This has widespread ramifications to consumer spending and confidence. "There's a difference between having an expansion and an economy that has recovered," says Lawrence Summers, Obama's chief economic adviser. The president said there is still "a long way to go," especially in creating jobs. Bernanke said there is a risk that labor markets will remain weak through 2010 because growth may be too anemic to create jobs. However the employment picture is getting stronger faster than most realize.  I will comment seperatly on this in the coming week.