Thumb In Keynesians' Eyes: Here Comes Economic Strength... Again

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 |  Includes: IJR, IYT, SPY
by: Gary Jakacky

Seeking Alpha readers know that I follow the signals given by markets---full of millions of well educated, informed investors putting their money where there mouths are---over government bureaucrats.

So what do we make of the incredible strength in this most recent bull market rally, which began in late June? First, a closer look. The chart below shows that, starting in June, investors appetite for high growth, high(er) risk, small companies began to surge. Look closely at the performance of the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) with the iShares S&P Small Cap ETF (NYSEARCA:IJR) over the last year.

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source: www.bigcharts.com

At first glance it appears that IJR has been consistently outperforming SPY since the rally which began last November. But remember we must adjust for risk. IJR has a beta of 1.19. We should expect it to be stronger than SPY when the market surges. And in fact it has been. But something happened in late June: even adjusted for risk, IJR blew the broad market out of the water.

The chart below focuses on market action since June 24th, when the rally began after the "tapering scare."

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The broad market is up about seven percent. Using the mathematics of beta as shown here, we can see the expected return for IJR should be about 8.3%:

(7.0) x (1.19) = 8.33%

What does it mean when we see IJR up thirteen percent over this span? Simple: Investors are pouring money into high beta, small growth stocks typical of IJR, which after all boasts a PE of 27, according to the iShares.com website.

This summer's rally was right in the face of those who claim QE was (1) behind economic improvement of the last few years and (2) the strong stock market over this period. The prospect of a taper has not slowed economic growth. SPY scored a solid gain the past three months.

In contrast, since September 18th's one day "we won't end the taper" rally, SPY has fallen more than 5 points.

Nor do we see a "shutdown related selloff in IJR" over the last few sessions. The central tenet of Keynesians is that confidence and expectations play a crucial role in how the economy performs. I guess the prospect of a shutdown and debt limit fight doesn't scare investors that much.

Nor should it scare you. The economy is doing fine.

What a thumb in Keynesian's eyes, which I referred to in this previous article.

Now I dare say it is a bear knuckled fist. Just look at the recent data:

  • Consumer Sentiment: Despite all the howling, from the President to Krugman, about gridlock and dysfunction in Washington, sentiment has barely blinked.

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  • Durable Goods Orders: Businesses do not order these big ticket items unless they are growing more confident about future sales. Working their way higher for over a year!

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  • Chicago Purchasing Managers Index: again, strong in recent months.

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  • and the most recent data on manufacturing: A lot of strength, everywhere.

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Do I really have to talk about recent strength in the iShares Transportation average ETF, (NYSEARCA:IYT)? Strong railcar loadings? What will happen to consumer spending as gasoline prices continue to fall?

As I alluded to last June; this shows the complete bankruptcy of Keynesian Economics. 2013 has seen a fiscal cliff, a sequester, the slowest rate of growth in government spending since the Korean War, a solid thumbs down on another Mideast entanglement, and now a government "shutdown." The economy should be falling apart, stock prices tanking, and bond prices soaring. Oh no! Not another graph? Why not...Keynesians never learn:

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I hope they enjoyed the one week "no-tapering" rally!

Yes: the dumbed down expectations for economic performance can't hold a candle to recoveries and bull markets in the past. But things are slowly getting better: and investors know it.

Disclosure: I am long SPY, IYT, IHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.