What's in store for the U.S. stock market this fall? How excited can one be when they read something like this summary in the Financial Times:
"Uncertainty over global growth, renewed U.S. congressional battles over the country's debt limits, the possibility of instability in the Middle East and expectations that the Federal Reserve will begin tapering measures in the coming weeks will weight on the market ..."
And, to add to this:
"Equities appear caught in a Catch-22 whereby strong data stoke Fed tapering fears, while weak data aggravate earnings-per-share jitters, leaving stocks struggling either way."
This leads us into the comments of Mohamed El-Erian, chief executive and co-chief investment officer at Pimco, to write,
"Which brings us back to this week's data, including high-frequency indicators of economic activity and the monthly employment report. Unfortunately, these numbers are unlikely to point to anything more encouraging than an economy that is moving forward only in second gear - i.e., one that is expanding too tepidly to decisively overcome the combined pressures of inadequate aggregate demand, lukewarm supply responsiveness and remaining pockets of overleverage."
Analysts got all excited last week when the revised figure for second-quarter real GNP growth was quite a bit higher than the original number. One should note, however, that when one calculates the year-over-year rate of growth of real GDP, the second quarter number still shows only a 1.6 percent rate of increase … pretty "tepid" by Mr. El-Erian's analysis.
The second quarter growth rate is now higher than that which was achieved in the first quarter, 1.3 percent, but down from the year-over-year rates of growth in the last two quarters of 2012, which were 2.0 percent and 2.1 percent respectively.
One should also note that the growth rates for industrial production have shown a downtrend over the same time period. In the third quarter last year, the year-over-year rate of increase in industrial production was 3.3 percent. In the fourth quarter of 2012, the number dropped to 2.7 percent. In the first quarter of 2013, the growth rate fell further to 2.4 percent and in the second quarter the rate of increase was only 1.8 percent. In July 2013, the number was even lower at 1.4 percent.
This picture seems to be consistent with the scenario for manufacturing in the Fall Business Preview published in the Wall Street journal:
"Momentum at big industrial companies, the face of U. S. manufacturing, is moderating. That means, they will have to put brakes on labor and capital spending to maintain or boost profits.
With little evidence of robust growth in the U. S., continued weakness of the eurozone and a slower than expected growth in China, industrial companies that make big equipment and machinery-as well as the hundreds of thousands of small parts that go into cars, washing machines and airplanes-are expected to rein in costs.
Capital spending by large U. S. companies will slip 3.4 percent this year from 2012, and fall 8.0 percent in 2014, according to forecasts by Fitch Ratings."
That is, either profits are not going to be strong or the economy is not going to expand much faster ... or both!
This brings us back into the CAPE war. CAPE stands for cyclically adjusted price-earnings multiple, a subject that has gotten a lot of headlines recently. (John Authers raises this debate to an even higher level in today's Financial Times.) If the CAPE measure is above its historical average, then this indicates that sooner or later the stock market must decline … must revert to the mean of the series. Right now, the CAPE measure is significantly above its "mean."
There are two ways that the CAPE measure can fall. First, earnings can rise to catch up with stock prices that rose in anticipation of the rise in future earnings. In the second case, if earnings do not rise then stock prices must fall to bring the CAPE measure back into align with its historical average.
Thus, the debate centers around whether or not future earnings are going to rise or not.
Jeremy Siegel, economist from the Department of Finance at the Wharton School, UPENN, and one of the combatants in the "CAPE war" believes that profits are going to surge ahead and justify the currently high CAPE figure.
On the other hand, I find it hard to believe that corporate earnings are going to be very robust over the next year or so given the current economic environment we find ourselves in and given the data that were presented above. Hence, I tend to be one that believes that the stock market is over-priced in the current environment.
The reason that the stock market is over-priced currently, I believe, is that the efforts at quantitative easing on the part of the Federal Reserve have unduly inflated stock prices. The Fed's quantitative easing has hoped to create a "wealth effect" that would increase consumer spending and get the economy moving more rapidly, but, unfortunately, I believe that this has not occurred.
In the Wall Street Journal's Fall Business Preview, cited above, we read:
"Sluggish back-to-school sales are a warning sign that it could be a tough holiday season for retailers.
Shoppers have prioritized spending on big-ticket items like appliances and cars, leaving them in a discount-hungry mood when it comes to other purchases. The worry for retailers is how big a hit their bottom lines will take from the deep promotions and offerings like free shipping needed to spur sales."
Seemingly, consumers are not going to pick up the slack in the economy and with longer-term interest rates rising, there is fear that the rebound in the housing market will slacken. With deleveraging still taking place in households and with a dreary picture for long-term joblessness, the wealth creation efforts may not be too effective. The wealthy, who are the biggest beneficiaries of higher stock prices just do not spend on basics the way the less-wealthy do.
Unfortunately, I just am not very optimistic about how the stock market will perform in the remaining months of 2013. As much as anything, the weak economy dominates the scene. Furthermore, in my mind, a military excursion into Syria will also not help the stock market.