The past week's economic reports included April reports on new and existing home sales, with moderate improvement over a grim March; new jobless claims that show a rise over April but still indicate very slow improvement on the 4-week average; and 0.4% growth of Leading Economic Indicators. Slow economic improvement seems to be the consensus.
Yet the stock market is on a long bull run, seemingly outrunning the economy. The S&P 500 has gone over 470 days without a 10% or greater correction, and four years without a closing lower than the 150-day moving average. The Dow is on a similar run of flirting with record highs on a regular basis.
How does this reconcile with slow economic growth? Are the S&P and Dow set to come back down to earth a bit?
Many analysts this month are warning of impending market correction and the likely bear market to follow… just as they did in the first quarter of 2014… and the fourth quarter of 2013… and so on. Back in January of 2014, Byron Wien, the vice chairman at Blackstone Advisory Partners, said that the growth of 2012 and 2013 has the market set up for a 10% correction because "everybody's on one side of the boat… when sentiment is euphoric, the market is vulnerable." Indeed, investors seem to be charging ahead and ignoring the doom-and-gloom predictions.
While most agree that a market correction is inevitable, there is a divergence of opinion on when it occurs, and what follows – a bear market or a resumption of growth.
Consider that even with the current market levels, Q1 2014 earnings growth was below expectations at 2.1%. However, according to FactSet Earnings Insight, analysts expect it to increase for the remaining quarters to 5.8%, 9.6% and 10.1% (in order).
The question is: why? Where is the earnings growth coming from? Housing reports, job reports, and wages do not seem to support this sort of optimism with the economy at large – at least not yet.
It is insightful that while the S&P 500 and the Dow are enjoying these growth rates, the NASDAQ and Russell 2000 indices have seen slower growth, with the NASDAQ leveling and the Russell on a clear downward trend. The S&P and the Dow represent major, large-cap companies. The Russell 2000 is smaller cap with the NASDAQ as a mix.
Even more telling, there is a growing split within each index. While the S&P overall is at a record level, within the large-cap benchmark index, the average stock has experienced a 7% drop. The average NASDAQ stock is down 22% compared to a 4% drop in the composite, and the average Russell 2000 stock has declined around 20% compared to a 7% drop overall since March. A few large players are pulling each index up.
Perhaps we are already heading toward a correction by the majority of stocks, masked by the performance of a few.
The International Business Times featured a recent article that suggests earnings are not the issue. The author, Mike Obel, contends that the economy is not being driven by the overall health of the economy or corporate earnings, but instead by the enormous amount of money pumped into the system by the Fed's stimulus program.
In essence, the Fed has been inflating the money supply hoping to get it to Main Street and start the economy, yet most indicators show that it is stuck in Wall Street instead as cash reserves.
So when the Fed does finally remove the stimulus and allow interest rates to rise, are we to believe that stocks will rise at the same time? That seems unlikely. Are experts assuming that the money supply will finally find its way to Main Street through investment and job growth? There is no obvious sign of that happening, either.
We seem likely to stay in a holding pattern of very slow growth until the end of the Fed's stimulus program in late Q3-early Q4. Unrealistic earnings expectations may catch up with the current high flyers by then, and the larger market does not seem to be growing fast enough to carry the load – so if Fed actions stay on schedule, that time seems like a likely spot for a correction.
What happens after that is almost impossible to predict, because any such correction might spur further Fed actions or other unpredictable responses – especially right before the midterm elections.
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