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ISM indices say the "new normal" economy is a no-show

Just came back from touring fabulous Cape Town. Really a gorgeous city that reminds me of the best of San Francisco, San Diego, and even Hong Kong. I'll post some photos in a bit. Anyway, I am happy to see that the market is up, and it would appear that once again it's because the news on the economy has proven stronger than expected. The ISM manufacturing index (above) was stronger than expected, and as my chart suggests, this is fully consistent with the 3-4% economic growth rate (if not more) that I've been expecting to see for the past year. It's a bit weaker than the fabulously strong levels that were showing up recently, but it is not supporting the popular "new normal" economy theory, in which growth registers a feeble 2-3%.

Most encouraging was the employment index (above) which is still at very strong levels that have been seen only rarely in the past several decades. This is very good news, since the weakest part of the recovery so far has been jobs and business investment, and the ISM index suggests that the manufacturing sector has shrugged off this malaise quite nicely.

My thesis is still in place: this economy is growing at a 3-4% pace, which is not very impressive given the extent of the recent recession, but it is stronger than the market has been expecting, and that is enough to drive equity prices higher and corporate spreads lower. It is also serving to weaken the dollar, since a moderately growing economy reduces the need for the world to seek shelter in the dollar for fear of a double-dip recession or worse.

Since 10-yr Treasury yields are still hovering just under 3% (a level that is only consistent with a market that is fundamentally bearish on the economy and very concerned about deflationary pressures that presumably arise from sustained economic weakness), I believe I am still correct in saying that the equity market is cheap and the Treasury market is very expensive.

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