WSJ: Wall Street Sees Dark Clouds Ahead


Wall Street professionals earn a lot of their oversized paychecks playing the roles of modern-day clairvoyants, peering into the future and telling investors where the economy is heading.

As the presidential election drones on, you could be forgiven for thinking that the country is headed over a cliff. After all, that's what the one guy keeps saying about the other guy.

Here's a news flash: Whoever wins, the country probably isn't collapsing.

But that doesn't mean there isn't a lot of uncertainty about the economy—and lots of reasons to be cautious.

We asked some of the savviest fortune tellers on Wall Street to look beyond the election rhetoric and give a sense of what to expect in the next six to 12 months.

Specifically, they were asked to decode some little-known but useful economic indicators and explain what they mean for your investments.

Here's the short version: Keep your head down for the next few months. There are dark clouds on the economic horizon.

Book-to-Bill Ratio
The semiconductor business is losing its sparkle, at least according to the book-to-bill ratio—which compares new orders (those "booked") to those orders that have been shipped and billed for. Semiconductors provide the "brains" to run all sorts of electronic gadgets.

Recently, the ratio has been steadily fizzling, down from 1.12 in March to 0.87 in July. This means the sector fell into contraction. Readings below 1 mean sagging chip sales.

"The book-to-bill ratio is bad and the tech sector will struggle for six to 12 months or even more," says Trip Chowdhry, managing director of research at Global Equities Research in San Francisco. He says the weakness is caused by uncertainty from the euro-zone crisis and the forthcoming U.S. election.

But he adds: It could turn around on a dime, when or if those problems get resolved. At that point, small investors might want to think about picking up tech stocks through a diversified fund such as the Technology Select Sector SPDR (XLK) exchange-traded fund. It holds a basket of technology stocks, including Apple (APPL), Microsoft (MSFT) and Google (GOOG).

ISM Manufacturing Survey

America's manufacturing engine has misfired. Starting in June, the sector slipped into contraction, according to monthly data from the Institute for Supply Management. It's a worrying sign.

"In many respects, this [economic] recovery has been driven by manufacturing," says Bill Stone, chief investment strategist at PNC Asset Management Group. But now it has descended into what he calls "a soft patch."

The concern is that weakness in the sector could plunge the whole economy into recession.

The ISM manufacturing reading in July was 49.8, a minuscule uptick from 49.7 in June but still below 50, which indicates the manufacturing sector is shrinking.

Still, Mr. Stone says it's not a collapse yet. Get worried when the reading is at 40 or 45, he says.

He says U.S. government bonds would perform well in that kind of environment as would so-called defensive stocks, including those of consumer-staples companies and utilities. Such companies do well in slowdowns because people don't cut back as much on the basic necessities such as food, toilet paper and soap.

The stocks tend to perform better than those involved in selling luxury goods. Look at the Consumer Staples Select Sector SPDR (XLP) ETF.

Michigan Consumer Sentiment Index
Consumers seem to have caught a stomach bug, so the news that the University of Michigan Consumer Sentiment Index has fallen since May should be disquieting.

"We normally see consumer spending decline as sentiment declines," says David Mann, regional head of research at Standard Chartered Bank in New York. "It's part of the overall story of sluggish growth."

It probably makes sense to avoid stocks that are sensitive to discretionary consumer spending. Companies that rely on selling things people don't have to buy, like luxuries such as fine wine and expensive clothes, could be in for a hard time relative to those that sell essentials, like food and gasoline.

Existing-Home Sales

The housing market might finally be reconstructing itself. The latest data show a string of robust price increases as well as moderate levels of properties for sale.

In June, the median price of a home rose close to 8%, compared with a year before. And the available supply of houses has fallen to less than seven months, according to the latest data from the National Association of Realtors.

"Six months' supply is probably average," says Paul Ashworth, chief U.S. economist with Capital Economics in Toronto.

While that is certainly good news for homeowners, it could also be good for savvy investors. If the trend keeps up, home-builder stocks, such as those held by the SPDR S&P Homebuilders (XHB) ETF might do well. Retailers that supply the home-improvement market, such as Lowe's (LOW) and Home Depot (HD), also could benefit if the trend is sustained.

Misery Index

Although the weak economy has everyone worried, it's those in the White House who should perhaps be most worried. The Misery Index is the sum of the percentage unemployment rate and the percentage inflation rate. Typically, when it rises voters choose the challenger over the incumbent.

There's the rub, because under the current president the Misery Index reads 9.7, up from 7.8 when President Obama took office, according to, which tracks the indicator.
However, unlike in the late 1970s when inflation was the dominant part of the index, this time it's unemployment.

"I think no one can make an easy case for improving the unemployment picture in short order," says Peter Rodriguez, professor of business at the Darden School of Business at the University of Virginia.

That may mean that this time President Obama gets a pass.
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