The market's rise since the start of the year on the resolution (of sorts) of the fiscal policy blockage is well documented and deserved in my opinion. With the debt ceiling resolved (or displaced) as well, most of what bothered investors was cleared away. But this week offers the first real economic reality check for investors. What follows could be confirmation of the positive mood or a stumbling block to keep us from moving further in February.
SPDR S&P 500 (SPY)
SPDR Dow Jones Industrials (DIA)
PowerShares QQQ (QQQ)
The rise of stocks this year is well-documented and well deserved, but can it continue after this week? The steep decline in Apple (AAPL) is behind the NASDAQ's underperformance year-to-date, but even its gain is awesome for one month. Stocks are benefiting from the removal of fear, with the fiscal cliff and the debt ceiling issues mitigated, investors are at least a little more confident that our representatives in Washington won't act negligently and put American credibility at risk. But this week offers stocks their first real economic reality check in several important economic report check-ups.
First, GDP will be reported for the first time for the fourth quarter of 2012. Economists are not expecting the same level of health as seen in Q3, with the consensus of economists surveyed at Bloomberg predicting just a 1.0% increase in Real GDP. Barron's posted the median expectation at 1.3% this weekend, but either way, it's a steep step-down from Q3's 3.1% growth. Wednesday's report has a range of economist views spanning from 0.5% to 2.6% growth. What if the result is even worse than the consensus expects?
Obviously, the market will look forward, realizing that Q4 was burdened and that the economy and stocks were frozen by the fiscal cliff last quarter. There was a real economic impact caused by the deadlock in D.C. and the build up to the fiscal cliff. So investors will probably look past the expected soft growth for Q4 and look forward to the potential for 2013. However, if the news is worse than expected, then support is destabilized for stocks nonetheless.
Lucky for investors, Wednesday also offers the latest Federal Open Market Committee (FOMC) Monetary Policy Statement. At this point in the slow recovery, I just cannot anticipate a Fed pulling away any of its supports. The real estate recovery is just picking up serious steam now and it would be counterproductive for the Fed to pull the rug out from under us here. Besides, all indications are that inflation is still not an issue, and with unemployment still at intolerable levels, the Fed remains in agreement with its policy to support employment and pricing stability by keeping supports in place here. We can only pray they don't express too much qualitative optimism and call asset purchase plans into question.
As for inflation, we'll get a look at that when the personal income and outlays data is reported on Thursday. The Core PCE Price Index, the Fed's favored inflation gauge, is a part of that report. Economists are looking for a small 0.1% increase month-to-month, following November's no change. Such a report would be supportive of investors, who want to no sign of inflation so the Fed will remain supportive.
The big test for the market will come with the economic report that many call the granddaddy of them all. The monthly Employment Situation Report is due on Friday. Investors will want to see the unemployment rate decline and private nonfarm payrolls pick up pace. The economists' consensus sees an unemployment rate improvement to 7.7%, from 7.8% the month before. Of course, the real unemployment rate is much higher, but it's improving as well. I expect the market will be more interested in the nonfarm payroll figure and signs of job creation in America. Economists currently expect private nonfarm payrolls to increase by 185K, versus the 168K increase in December. If we get a stronger figure here, stocks would have support to sustain them through February.
Besides the economic reports offering reality check for the market this week, several stock reports do the same for their own shares and for the good feeling in the market this week. Facebook (FB) for one faces its own put up or shut up moment, with its latest EPS report set for Wednesday. After its fall from grace post IPO, the company has recently revived hope with new initiatives in advertising income opportunities and in search. Boeing (BA) has a similar moment Wednesday when it reports earnings, given the latest questions about the 787 Dreamliner. News of order growth and little or no cancellations would go a long way for its shares. Good news from suffering stocks generally should be good for investor sentiment, but disappointing news might serve as a reality check on stocks broadly given their recent rise. So keep an eye on these two.
Investor sentiment will be measured this week for January, when State Street (STT) produces its index. I expect this figure to improve substantially in January/February, as capital flows into equity funds must have portfolio managers at work distributing it into riskier assets given macroeconomic risks removed (or at least displaced) this month. The index measures just that issue among institutional investors.
When all is said and done, I expect the changed feeling about D.C., with the removal of those big risks, to not only support the economy and stocks, but also consumer sentiment and spending. Several measures of consumer sentiment and spending will also be reported this week, from Consumer Outlays to the three consumer sentiment measures by the Conference Board, University of Michigan and by Bloomberg. I look for gains in those indexes, which I do not see reflected in economists' expectations in Bloomberg's surveys. In the end, though, real economic recovery will dictate what happens here, and real earnings growth will dictate what happens with stocks eventually (outside of P/E expansion), so this week's economic reality check is of great importance.