Why are Investors so Skeptical when many Reports on Economy seem Generally Positive?
It seems as though you cannot open a financial newspaper or watch a financial news program these days without someone suggesting that a significant pullback in the equity markets in the short term is inevitable. This leads us to wonder why investors are so skeptical when many economic reports seem generally positive. While it may be reasonable to argue that the stock market has rallied too high and too fast absent any significant gains on the economic front, it is hard not to also argue that the underlying economic foundation in the U.S. is solidifying to the point where a bear market or economic recession, in the short term, seems unrealistic. To understand this point of view, consider the various economic reports that have hit the wires over recent weeks:
- Durable goods order increased by 0.8% in April vs. an analyst consensus estimate of 0.7%, though a large part of the increase was attributable to a large quantity of defense equipment orders.
- The Case-Shiller 20 City Home Price Index showed that existing home prices rose by over 12% on a year-over-year basis in March. While the rate at which prices went up decreased from April, the upward trend it still positive.
- The Conference Board reported that Consumer Confidence rose in May to 83.0 from 81.7 the month prior.
- The Richmond Fed Manufacturing Index was unchanged at 7 for the month of May. A reading above zero for this particular index generally indicates an expansion in the region’s manufacturing.
- According to the Federal Reserve Bank of New York, the Empire State Manufacturing Index rose to 19.0 in May, its highest level since mid-2010. This increase was well-above expectations as the analyst consensus estimate was just 5.4.
- The Labor Department reported that the number of people who applied for unemployment benefits recently fell to 297,000, the lowest level since May 2007.
- The Consumer Price Index (CPI), an often watched barometer of inflation, increased by a seasonally adjusted 0.3% last month and has risen 2% over the past 12 months.
We are not suggesting that the economic recovery is picking up steam. To the contrary, we remain frustrated with the pace of this particular economic recovery and contend that GDP annual growth rates are likely to remain below 3.0% for the foreseeable future. Evidence of this sluggishness can be found in the 1st quarter 2014 GDP growth rate of a mere 0.1% on an annualized basis.
Despite this, we believe that the U.S. economy is not at risk of retreating, thanks in large part to an activist Federal Reserve waiting in the bullpen, and that the stock market is poised to experience a strong second half of this year, though there will likely be more intermittent bouts of short-term volatility along the way. To this end, despite the “wall of worry” that has hung over the markets thus far in 2014 like a dark cloud; the S&P 500 index has risen nearly 3.7% year-to-date, on a total return basis, according to Bloomberg as of May 23, 2014. Of course, it is important to realize that past performance is not an indication of future results.
We, at Hennion & Walsh, also contend that there is more upside potential beyond 2014 in this market cycle based on our belief that we are in the midst of a secular bull market. A secular bull market is generally referred to when the overall trend of the stock market is “bullish” longer term, lasting between 5 and 25 years. During secular bull markets, stocks tend to rise in price more than they fall in price with the declines being less significant and offset by the subsequent increases in prices.
However, investors will need to challenge themselves going forward in this market cycle to be very selective in terms of finding additional pockets of risk-adjusted return possibilities in a wide range of asset classes and sectors. Investors also need to level-set their expectations for what defines a good year in the stock market, following a year in which the S&P 500 index rose over 32% in 2013.