- Economic data is giving mixed messages about stocks.
- August data may move the market in surprising ways.
- The bond market has its own message.
I think you should beware of Mr. Market over the next eight weeks, because he could be sending you some misleading information.
To begin with, there's the August rally, "on track to be the best such August in 14 years," according to a CNBC (I know, I know, but even so) piece from one of their senior editors detailing why we shouldn't be afraid of the markets. I advise you to click on the link here, partly because it contains a decent recapitulation of why bullish sentiment is so high, partly because it's not from one of their manic-depressive traders, and partly because I want to call your attention to the obverse sides of the apparently sunny points.
The first part of the piece worth noting is the claim that we're on track to be the best August since 2000. That's going to take a pretty big move over the last two days, with the S&P up 3.6% on the month with two days to go and August of 2006 up 4.4%. With news of a third Russian front opening up in the Ukraine and the last two days of August being historically weak for stocks, that looks like a very tall order. Maybe it should be - August of 2000 was followed by four straight months of declines, so I'm not sure why we would be especially eager for the comparison.
It's also worth noting that the sharp August rebound off the two years-old QE trend line has come on extremely light volume.
The piece then goes on to highlight job growth, a common enough observation these days and worth thinking about. For one thing, employment is a lagging indicator. The year 2000 was a very good year for job growth and will probably remain stronger in percentage terms than 2014 is likely to be, yet it was followed by a recession. In the second place, the jobless claims data are suggesting that the party is nearly over in jobs growth. The insured unemployment rate has been at 1.9% (seasonally adjusted) for about two months now, and while it has gone lower in the past, historically the episodes below 2% have been short-lived. We are much closer to the end of the pickup than the beginning, though total employment typically will keep going after a recession has already started.
The second is GDP. The second estimate of second-quarter GDP is due this morning, and is expected to be close to the original 4.0%, while the third quarter is tracking at 3.3%. Those seem nice, but it still leaves the first half little better than 1%. The pattern of inventories this cycle has been for two consecutive quarters of above-trend growth to be followed by below-trend episodes, so if the third quarter does get a boost from inventories it is likely to reverse in the fourth quarter. The weather-related rebound is starting to fade, leaving 2% still a challenging target for 2014.
But the Fed won't be seeing the 2014 GDP rate at its next meeting. It will be seeing August retail sales, which (excluding auto sales, about which I have no idea) should look good: The data from both weekly chain store reporting services is good (for a change) with one week to go, suggesting that the back-to-school season is as good as can be expected and should benefit from the rebound from an anemic July. That flattery, coming on top of what is likely to be another good jobs number (going by weekly claims during the August measurement period) may actually lead to Mr. Market getting spooked by the prospect of a less-accommodative Fed.
Yet the sales improvement may be illusory:
source: US Commerce Dept, Avalon Asset Mgmt Co
The chart above suggests that retail sales are not on some glorious new ascent, but have plateaued at below-average growth levels.
I consider consumer confidence measures to be more useful as contrarian indicators that tell you where the stock market has been than anything else. The fact that confidence is now at a seven-year high is one of those things that hard-core bulls love to repeat, but the type of high that always make me nervous.
According to FactSet, the earnings growth rate for the S&P 500 was 7.7% in the second quarter, with 10 companies still to report (I don't know how people keep coming up with a de facto range of 10%-12%). Combined with the 2.1% growth rate for the first quarter, that averages out to about 5% for the first half. I happen to think that 7% is still a likely result for 2014, but that nevertheless leaves us with a 20 times multiple (not 16, not 18) on 7% growth.
Last but not least is the bond market. I certainly get that central banks have created an artificial demand for many sovereign bonds around the globe, but even so current yields worry me, and they should probably worry you. The U.S. ten-year yield closed at a 52-week low of 2.36%, and whatever reasons you may want to use to explain it, a conviction of accelerating economic growth is not on the list. Yes, there's a chase for yield, but I cannot help but think these multi-century lows in European bond yields are giving us a message that we are going to regret not giving more heed. Missing cues from the bond market has been a lugubrious hallmark of the stock market, I'm afraid.
The employment market implying a peak, retail sales growth at a feeble plateau, 7% corporate profit growth, bond yields at record and near-record lows around the globe - and a market priced at 20 times earnings, often justified by saying it's not at 30 times, like 1999. Uh-huh. I don't see the economy tanking this year, but stocks are overbought across most time horizons, above all long-term. Mr. Market could have some crazy rides in store over the next couple of months.