Recession Draws Closer

Stock market benchmarks dropped today, with the Dow off more than 200 points at the close. Earnings season is winding to a close with a mixture of good news and bad news. The good news is that a surprisingly large number of companies managed to surprise Wall Street with better-than-expected results. The bad news is that results were still dismal. The main thing the surprises prove is that analysts are increasingly incapable of delivering accurate earnings estimates.

The drumbeat of bad economic news resumed today after a brief respite. The Commerce Department reported that Gross Domestic Product for the second quarter increased at a +1.9% annualized rate. Since economists had projected +2.3% growth, this was a disappointment. More significant, GDP for the two prior quarters was revised downward. The last quarter of 2007 went from +0.6% to -0.2%. Of course these things can only be judged in hindsight, but it now appears possible that we may look back and say that a recession began in October 2007.

Today also brought the weekly employment report, which revealed that more Americans filed claims for unemployment last week than at any time in more than five years. Some reports suggest that this week’s number of 448,000 new claims is artificially inflated by government efforts to encourage those who lost their jobs some time ago to finally request benefits. This may be so, but the trends are still worrisome. More unemployment means less consumer confidence, which leads to lower consumer spending. The growing number of bankrupt retailers is evidence this process is already well underway. Familiar names like Mervyn’s, Bennigan’s, Steak & Ale, Linens ‘n Things, Lillian Vernon, and Sharper Image have all surrendered to business reality in recent months. We suspect the list will grow longer.

The biotechnology sector is shrugging off the economic bad news and picking up even more momentum this week. This morning brought an offer from drug giant Bristol Meyers Squibb (BMY) to buy full ownership of ImClone Systems (IMCL) for $60 a share – a 29% premium over Wednesday’s close. IMCL shares proceeded to close even higher today at $63.93. This suggests that investors think a better bid will be forthcoming. Biotech sector funds will benefit to a greater or lesser degree depending on their ownership of IMCL. All of our model strategies own biotechnology funds so we are in good position to benefit from this trend.