Economic data suggests moderation not recession

Last two days, the market faced more economic data to assess the state of the economy. Yesterday, the consumer confidence number plunged to the lowest level in 7 months, triggering fear that the economy may be falling harder than expected. Fed FOMC minutes also showed that many of the fed officials were hawkish, citing need for additional tightening. However, Fed official also noted lower energy price and faltering housing sector as mitigating factors for further interest rate increase. In fact, lower energy price and slowing housing market are exactly what has been happening. In addition, preliminary GDP number came in at 2.9%, higher from 2.5% last month, showing the economy is holding. However, this number is still far below mid 5% that we were seeing early summer, indicating cooling economy. Finally closely Fed watched figure non-core PCE deflator (Bernanke's favorite number to gauge the inflationary pressure) came at 0.1% gain, smallest gain this year, indicating comfortable inflation level; yet overall personal spending rose healthy 0.8%, showing consumers are not dead.

All this economic data shows the economy moderating, but not entering recession. I believe that Fed won't be raising the interest rate this year. As more data unfolds into this scenario, I am betting that we are set up for the nice year rally after choppy Sept and Oct. I still expect the economic data to be mixed as the economy makes transition from robust growth into subdued growth. However, I am expecting lower energy price as the year progresses, barring another terrorist attack and Iranian nuclear escalation. In addition, as the housing enters slowest time of the year, I see steep deceleration in the housing market. I was surprised to see that prices of new homes and condos are falling by more than 10% with various incentives (free appliance and floor upgrades). I visited KB home just across the street from where I live and found out that sold homes are coming back to the market; people are actually giving up their deposits and rethinking their decision to buy homes. I see no reason for Fed to raise rate from this point on.

I said this to some of you before: if the rate rises above 5.5%, I am out of the market. With weakening housing market, I believe the economy is a fragile state. But as long as Fed stays at the current rate, I believe it can still manage less hard landing. In this environment and under my thesis of no more rate hike, I like financial sector first. I think they will be the first to benefit from the stable interest rate environment. I also emphasize having exposure to non-cyclical sector such as health care and biotechs. As we get a confirmation from Fed they are done, we can move into tech, retails, and even home builders.