U.S. Equity And Economic Week In Review: There's Not Much To Get Excited About, Edition

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Includes: DIA, QQQ, RINF, SPY
by: Hale Stewart

This week's housing news was mixed. While new home sales increased 2% M/M, they declined 6.1% Y/Y. Existing home sales, however, dropped a whopping 7.1% M/M. Bill McBride at Calculated Risk argues low inventory and pockets of regional weakness are to blame. The New York Times added that recent market volatility probably lowered sentiment, contributing to the weakness. This graph from the FRED system places the information into a longer-term context:

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Existing home sales moved sideways in 2015. New home sales peaked early, trended lower until the end of the summer, moved sharply higher and then backed off a bit of the last few months. But in general, the trend is more or less sideways. My co-blogger argues we're late in the housing cycle here. Also see this post from Political Calculations. It's also important to remember the new home market is far more economically important, because it creates far more economic activity.

The Census reported new orders for durable goods declined:

New orders for manufactured durable goods in February decreased $6.6 billion or 2.8 percent to $229.4 billion, the U.S. Census Bureau announced today. This decrease, down three of the last four months, followed a 4.2 percent January increase. Excluding transportation, new orders decreased 1.0 percent. Excluding defense, new orders decreased 1.9 percent.

Taking a longer view, notice that all three series (total, ex-defense, ex-transport) have been moving sideways for approximately 12-18 months:

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This falls in line with a general theme of weaker industrial production, which, thanks to a strong dollar, weak oil and declining emerging markets, has been trending lower for the last 12 months as well.

Finally, BEA released their last estimate of 4Q15 GDP, which was 1.4%. This was another increase: the first release printed at .7 and the second at 1%. Here's a table from the latest report:

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While personal spending on durable and non-durable goods was positive, the 4Q15 figures were noticeably weaker. For the second consecutive quarter, business investment contracted, thanks to decreases in structures, equipment and intellectual property. Even exports subtracted from growth, falling 2%. Without the consumer, the US would be probably be in a shallow recession right now.

Perhaps most concerning for equity investors was the corporate profit data:

Profits from current production (corporate profits with inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)) decreased $159.6 billion in the fourth quarter, compared with a decrease of $33.0 billion in the third.

As the following charts show, profits and earnings are, at best, in moderate shape:

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The Atlanta Fed's GDPnow model predicts 1Q GDP of 1.4%. The Cleveland Fed's yield curve model shows 1.9%, while Moody's high-frequency model forecasts 1.5%. The Atlanta Fed's recession predictor shows a 10% probability, the Cleveland Fed's model shows 8.82, while the NY Fed's model forecasts a 7.2% probability.

Economic Conclusion: There is clearly growing weakness. The decline in business investment continues and is growing. In the 3Q contraction occurred in structures and IP; the 4Q added equipment to the mix. And exports are now contracting thanks to the strong dollar and weaker overseas demand. The only good news is the US consumer, who, thanks to a strong job market, continues to spend. But even there we see a decline in the overall pace.

Market Overview: The market is expensive. The current and forward PE of the SPYs and QQQs is 23.53/21.55 and 17.55/18.15, respectively. Corporate profits are declining. From the latest BEA GDP report:

Profits from current production (corporate profits with inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)) decreased $159.6 billion in the fourth quarter, compared with a decrease of $33.0 billion in the third.

(See the charts above) Corporate profits declined in four of the last five quarters. This is negative for the markets. In addition, the performance to-date of the Russell 2000 (IWMs) and mid-caps (NYSEARCA:IJH) illustrate why I remain sanguine about meaningful future rallies. Let's start with a P&F chart of the IWMs, which represent the risk-based capital:

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Prices broke support that traces back to 2013 - this is never a good sign. Also notice the sharp 18% sell-off from 116-95 earlier this year. If you include the second sell-off that took prices down to 94, you'd get a bear market. Prices have rallied strongly, moving from 95-108, but there's still strong upside resistance.

Let's now turn to the IJHs:

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This chart is slightly better because the recent rally is close to moving through upside resistance. Though the MACD on the daily chart is not only high, but about to give a sell-signal:

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Between the weak 4Q GDP growth rate, soft 1Q growth predictions and declining corporate profits, there is little to get excited about.