Growth Is Bad for Stocks?
The second quarter GDP numbers were released on Wednesday, June 30, outpacing estimates with a healthy 4% growth in the economy. The Q1 GDP numbers were also revised upward to show only a 2.1% contraction instead of the 2.9% of the last revision. Wall Street greeted this news with a 317-point sell-off the next day, accelerating an almost 500-point drop since Monday.
To the layman, this just seems absurd. To those familiar with the market, it means that investors are concerned about the reaction of the Fed and any information that makes investors think a raise in interest rates is on the way.
That is a bit simplistic – there are concerns about other things such as the Argentinian debt crisis and probably some profit-taking going on. But the point is that almost everyone expects the economy to continue to grow, the Fed to eventually raise interest rates, and the stock market to correct. The real question is when.
The Fed Stays the Course
So far, the Fed has given little indication of changing course. Their premise has been that wage gains have been low enough that inflation is still in check, and that a lot of long-term unemployment slack remains to be consumed.
The combination of these things leads to effects such as sluggishness in the housing market, as more people are getting back to work but they are not in position to re-enter the housing market just yet. Thus, the gradual easing of the stimulus continues with no interest rate changes.
That forecast seems to be spot on so far.
209,000 new jobs were created in July, making this the first six-month run of 200,000+ jobs created in almost fifteen years. May and June job creation was also revised up by a combined 15,000 jobs. Even so, the unemployment rate ticked up to 6.2%, as discouraged workers attempted to re-enter the labor force.
Meanwhile, wages showed essentially zero growth in July and 2% for the past year, which is hovering around the inflation mark for the same period. Perhaps there is so much slack to take up with the longer-term unemployed that modest job gains are simply absorbed by the market, and there is little pressure to raise wages because there is still a large number of total unemployed (although that implies a match between job seekers skills and available jobs that may not exist).
Whether that is the case or not, wages are not rising and inflation is still staying low. Correspondingly, the Fed is sticking with their plan to reduce bond purchases and leave interest rates alone.
Are the 2nd quarter growth numbers truly a continuation of the growth trend with Q1 numbers as the weather-related aberration, or are they an overstated rebound from the Q1 numbers, analogous to a stretched spring that will eventually equilibrate somewhere in between? So far, the answer appears to be the former, with most indicators pointing toward steady slow growth. In the short-term, this sell-off is likely to be a temporary correction in a continuing bull market.
Even so, stocks are still somewhat overvalued and the collective earnings pressure is high on companies compared to growth projections. For that reason, it would not be a surprise to see the bull starting to lose more steam even as the economy continues to grow slowly and the Fed stands pat.
Most analysts expect the Fed to begin raising interest rates sometime next year, finally taking the stock market down somewhat. Unless there are some startling reports over the next two-to-three months, we agree with that assessment.