By Hale Stewart
This week's news confirmed that the US economy continues to grow moderately. The Fed's Beige Book and Conference Boards LEI/CEI release confirmed one another's general observation the economy is advancing, albeit slowly. The housing market continues to offer positive news while the industrial sector's weak growth continues. Turning to the markets, despite improvement in the 3Q earnings report, short-term technical analysis indicates a slight downward move is more probable through year-end.
On Thursday, the Conference Board released the latest leading and coincident economic indicators. Both rose .2% M/M. The LEIs were up .9% on a rolling 6-month basis - the third consecutive reading around the 1 level. But 5 of the 10 components subtracted from the monthly growth total. In contrast, all the CEIs contributed to the latest gain. The Conference Board described the potential growth forecast as moderate through the beginning of 2017, which confirms the overall assessment contained in Wednesday's Beige Book:
Reports from the Twelve Federal Reserve Districts suggest national economic activity continued to expand during the reporting period from late August to early October. Most Districts indicated a modest or moderate pace of expansion; however, the New York District reported no change in overall activity. Compared with the previous report, the pace of growth improved in the St. Louis, Kansas City, and Dallas Districts. Outlooks were mostly positive, with growth expected to continue at a slight to moderate pace in several Districts.
Two key real estate statistics were published this week. The Census Bureau released the latest building permits and housing starts numbers; the former increased 6.3%/8.5% M/M and Y/Y. Starts dropped 9% M/M and 11.9% Y/Y. However, the 5-year chart for both shows they continue to move sideways:
Another sharp drop in starts would be moderately concerning. However, building permits have increased modestly since the start of the year, interest rates are still low and Millennials are starting to buy their first homes. All these factors bode well for the new home market over the next 6-12 months. Finally, the National Association of Realtors issued another key housing metric this week: existing home sales rose 3.2% M/M and were up .6% Y/Y.
Industrial production - a key coincidental economic indicator - rose .1%. 2 major market groups (final products, non-industrial supplies) rose and 2 of 3 major industry groups increased output:
However, when looking at the major market groups, mining (read oil extraction) has been the primary driver of growth; non-industrial supplies have moved sideways since early 2015 while final products have edged lower over the same period:
Economic conclusion: The moderate growth path continues. As has been standard for the recent past, there are weaker economic numbers that give the bears just enough ammunition. But there is insufficient information to conclude there is anything except modest growth in the next 6-12 months.
Market Outlook: The market rose slightly last week: the SPY was up .4%, the QQQ increased .86 while the IWM advanced .53. Better yet, earnings news is encouraging:
First, earnings growth for these 81 index members is not only tracking better relative to what these same 81 companies reported in the preceding quarter, but also the 4- and 12-quarter averages. In other words, the earnings growth pace has notably improved relative to the recent past.
Second, the improvement in growth on the revenue side growth is even more notable, with Q3 revenue growth for these 81 index members notably better relative the preceding quarter as well as the 4- and 12-quarter averages.
Third, positive EPS surprises for this group of companies are tracking notably above historical periods. This could be interpreted to mean that estimates may have been too low ahead of the start of this reporting season. But the reality is that Q3 estimates didn't fall as much as had been the case with other recent quarters.
Fourth, positive revenue surprises are also notably tracking above historical levels. Given the earlier comment about the modest negative revisions to Q3 estimates ahead of the start of this earnings season, it is reasonable to interpret the revenue trends (both growth as well as surprises) as a sign of improvement in the overall earnings picture.
But the technical environment is still pointing to a slightly weaker market. The IWM is the most important chart for this argument:
The Russell 2000 recently broke an uptrend after forming a rounding top. Momentum is weak.
And the DIA (top chart) and QQQ (middle chart) recently broken an uptrend while the SPY (bottom chart) is moving sideways after failing to make a new high.
However, these aren't fatal developments, largely because the macro environment is still positive. The economy is still growing, although at an aggravatingly slow rate. And so long as that continues, the market will have a cushion.