Stocks As Economic Activity Indicators

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Includes: CAT, FDX, WMT
by: Disruptive Investor

Summary

The S&P 500 index has been trading sideways in YTD15, indicating a pause by market participants amidst rate hike uncertainty and weakness in corporate earnings.

FedEx has trended higher after March 2015 and this is indicative of improvement in global economic conditions in 2Q 2015 as compared to 1Q 2015.

While Caterpillar has also trended higher after March 2015, it has been due to recovery in oil prices, with China's growth momentum remaining weak.

Stock market indicators point to a better second quarter, but market participants remain cautious and bottom-up investing is dominant.

Government published data is one of the key sources to judge economic activity, even when government data always needs to be taken with a pinch of salt. Further, investors need to look beyond headline economic data for some real economic assessment. Just as an example, there was a period when headline unemployment was declining at a relatively robust pace. However, U6 remained meaningfully higher, indicating that the decline in headline unemployment was driven by several other factors such as increase in people, not in labour force, among others.

Besides government published data, stock markets are a good indicator of where the economy is headed, with stock markets representing the dynamic sector of the economy. While there can be indicators from the broader markets, individual stocks can also be excellent economic indicators. This article looks at the broad market and few individual stocks to judge the economic direction.

Looking at the broad markets first, the S&P 500 index has been flat in YTD15. In my view, there are several reasons for the sideways movement -

  • First, market participants are concerned about a potential rate hike and its impact on asset markets. Therefore, the markets have remained sideways until there is more clarity on the timing of a rate hike.
  • Second, economic activity remained relatively sluggish in the first quarter of 2015 and corporate earnings have also been mixed. Market participants would wait for further corporate data before the next move.
  • Third, Duke's Fuqua School of Business/CFO Magazine Business Outlook indicates that the US corporate sector expects earnings growth (next 12 months) to be 8.2% as of March 2015. Earnings growth outlook as of September 2014 was 11.7%. This is a clear indication that corporate growth is likely to be relatively sluggish in the coming quarters and the market is moving accordingly.

Overall, the broad markets do not indicate very strong corporate growth in the coming quarters, even as corporate growth and economic growth is likely to remain resilient. Further, the broader markets might not be happy with a strong dollar and I have discussed in one of my earlier articles on how a strong dollar has been impacting corporate growth.

Coming to individual stocks, FedEx (NYSE:FDX) is a good economic indicator and the stock has trended higher by 5.7% in YTD15, indicating relatively positive global economic momentum. An important point to note here is that FedEx declined from a high of $181.4 on January 22, 2015 to a 2015 low of $164.59 on March 27, 2015. This decline was in line with relatively flat economic activity in the first quarter of 2015. However, FedEx has again trended higher to $183.63, representing an 11.6% surge from 2015 lows, and this is an indication of pick-up in global economic activity in the second quarter of 2015. The GDPNow model from the Federal Reserve Bank of Atlanta also confirms this pick-up in economic activity, with the model now projecting second-quarter GDP growth to be 1.9%. I must add here that eurozone growth has also witnessed some revival in the second quarter of 2015. Therefore, with FedEx trading near 2015 highs, the indication is that global economic activity remains strong. Considering FedEx's outlook for the remainder of 2015, I remain positive on the stock and I also remain positive on economic activity.

Caterpillar (NYSE:CAT) is another excellent global economic indicator. In particular, the company is a good economic indicator for resource driven industries and production driven economies. From a high of $91.53 at the beginning of 2015, Caterpillar touched a low of $78.45 on March 15, 2015. In my view, there were two reasons for this decline - First, China's economic data continued to disappoint even after rate cuts. Second, oil prices bottomed out in January 2015, but the sharp decline in rig activity continued through the first quarter of 2015. After bottoming out in mid-March 2015, Caterpillar has trended higher by 12.0% and the upside has been driven by oil price recovery. China is not the reason for Caterpillar trending higher, as government data remains disappointing in China, and if government data is disappointing, real economic activity would be meaningfully lower than what data suggests. Considering the point that China's growth still remains uncertain and could be potentially lower in the coming months, I would remain cautious on Caterpillar. I would also like to point out here that a nuclear deal with Iran can take oil lower and result in renewed concerns in the oil and gas industry.

I must add here that Wal-Mart's (NYSE:WMT) stock is another good indicator of US economic activity, and with the economy primarily consumption based, Wal-Mart does tell a lot about real economic activity. However, I have refrained from discussing the stock as an economic indicator (which it has been in the past) because the stock has been impacted by several other factors in the first six months of 2015. Further, Caterpillar and FedEx Corporation are global indicators, while Wal-Mart is an indicator specific to the United States.

In conclusion, economic indicators from the stock market are indicative of recovery in global growth. However, the broad index is range bound and I believe that earnings in the coming quarters will determine the broad index trend. While I was overweight on the S&P 500 index at the beginning of the year, I am revising my outlook to neutral. I would advise against fresh exposure to the index. However, investors can still find value through a bottom-up investing strategy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.