Why investors betting on growth spurt could come up "snake eyes"
Boosted by a jump in a number of big-cap tech stocks, including Facebook (FB) and Amazon (AMZN), the Nasdaq breached the 6,100 level for the first time this week. Driving that rise were strong corporate profits in the first quarter.
But the "hard" activity-based economic data continues to disappoint in the wake of a 0.7 percent first quarter GDP print. Now some of the "soft" survey-based data that was so ebullient following President Trump's election are also starting to roll over.
With stock market valuations very rich -- by one measure, exceeded only by the run-up to the 1929 and 2000 market bubbles -- investors are clearly betting that the economy will bounce strongly, in part on expectations of pro-growth legislation out of the White House and Congress.
Is this faith misplaced?
Setting aside the political discussion (even as many analysts warn that tax cut legislation is likely to be pushed into early 2018), there's reason to think investors may ultimately lose their religion.
According to Gluskin Sheff economist David Rosenberg, evidence suggest the economy is very late in the business cycle. That means risks to the downside are increasing, while the potential catalysts for an acceleration in growth are dwindling.
Credit availability is tightening, with the Federal Reserve increasing interest rates by the equivalent of four percent since late 2014 based on the Wu-Xia Federal Funds rate calculation. Of the last 13 Fed tightening cycles, all but three have resulted in recessions.
Motor vehicle sales are slowing, with every major manufacturer missing expectations for April. The all-important American consumer, despite survey-based displays of confidence, are increasing their savings rate to a level not seen since last summer.
Other headwinds: Wage growth has slowed; core inflation is softening, a sign of waning demand; and most critically, bank lending activity is rolling over at a pace associated with the last three recessions. As loan performance deteriorates, credit standards tighten, and interest rates rise.
Apprehension over these warning signs explains why the bond market is suddenly easing back on risk, pushing the 10-year Treasury note yield down three-tenths from a high of more than 2.6 percent in early March. Put another way: While stock market investors continue to foam at the mouth, bond traders are strapping on their helmets.
So what are big-tech stock buyers looking at that has them so excited? Certainly, first-quarter earnings have been very strong. With 58 percent of S&P 500 components having reported through Friday, the index is on track for a 12.5 percent earnings growth rate -- the best since the third quarter of 2011, according to FactSet.
Moreover, the Atlanta Fed's GDPNow measure of second-quarter economic growth stands at an impressive 4.3 percent.
But Rosenberg believes this number will be revised down, as the Atlanta Fed's estimate of first-quarter growth was from an initial estimate above three percent. Wall Street economists, for their part, are looking for second-quarter growth near 2.7 percent.
This is based on a deterioration he sees in the March economic data relative to the overall first quarter average: Housing starts (down 11.6 percent), manufacturing production (down 0.5 percent) and core retail sales (down 0.2 percent). And on Tuesday, we learned the April ISM manufacturing index fell to a four-month low.
In short, the hand off to the second quarter is "hardly inspiring," he said.
If the bulls are to be proven right, according to Capital Economics, much depends on increased spending from U.S. consumers not only this quarter, but also through the rest of the year after the weakest performance in years in the first quarter.
Investors should keep an eye on your local shopping spots -- the mall, the big-box stores -- for a gauge of whether the stock market's confidence or the bond market's deepening concern is correct.
