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By HaleStewart September 27, 2015 9:24 am
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US Equity and Economic Review: The Market Will Continue to Meander, Edition

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer  

     Last week’s economic news was mixed.  While 2Q GDP was very strong, 3Q projections show a slowdown.  Durable goods orders continue their near year-and-a-half stall, as low oil prices and the strong dollar hurt demand.  Housing, however, continues to be a bright spot, especially new home sales.  Although the markets fell through technical support last week, the underlying economic environment should provide sufficient growth to prevent a bear market. 

The Economic Environment

     The BEA reported final 2Q GDP at 3.9%.  Numerous internals were strong: consumer durable goods purchases increased 8% Q/Q, while consumer non-durable purchases were up 4.3%.  As shown in this FRED chart, the US consumer’s 5-year spending history is positive, especially on durable goods (blue line):

Non-residential construction’s gain (+6.2%) was the largest since 1Q14.  Residential construction’s 9.3% increase was the third consecutive quarter of positive results.  Even exports posted a 5% Q/Q rise.  Overall, the third revision proved to be its best.  However, the 3Q is not looking nearly as rosy:

The Atlanta Fed’s GDP Now (top chart) has 3Q GDP at a little below 1.5%: Moody’s current estimate (bottom chart, yellow line) is 2.4% while the Moody’s survey’s estimate (bottom chart, green line) is 1.9%.  But although 3Q growth projections are lower, the Atlanta Fed’s recession index is low, with the latest reading at 13.3%:


Overall, it appears US growth continues to fall under the “two steps forward, one step back” model. 

     The housing market news was mixed.  Existing sales were down 4.6%, but this number’s decrease occurred after strong summer increases:

New home sales, however, increased 5.7% M/M and a very strong 21.6% Y/Y. 

As Calculated Risk notes, this number is far more important for the US economy than existing home sales as its ancillary impact is far broader.  Also, it’s possible the potential rate hike is pulling sales forward as consumers anticipate higher mortgage rates in the next 12-24 months. 

     Finally, durable goods orders declined 2% M/M and were 0% ex-transportation:

This data series has been flat since the end of 2013, about the time when the initial weak news from China starting to emerge.  The strong dollar and weak oil market provide the current headwinds.

The Technical Environment

     The market remains expensive.  The current and estimated PE ratio for the SPYs and QQQs is 20.59/21.55 and 16.45/18.45, respectively.  This means stocks need meaningful earnings growth to establish new highs.  As noted above, the 3Q GDP estimates are not encouraging (see also this analysis from Mornginstar).  Regarding the earnings outlook, Zacks noted:

Energy is no doubt a big drag, but there isn’t much growth momentum in other sectors aside from Finance and Medical, with earnings growth for 9 of the 16 Zacks sectors expected to be in the negative. Finance is expected to have another positive quarter, with total earnings for the sector expected to be up +8.6% from the same period last year. Excluding the contribution from the Finance sector, total earnings for the S&P 500 index would be down -9.0% from the year-earlier period. Keep in mind however that while the Medical sector growth is broad-based, Finance’s favorable growth numbers are mostly due to easy comparisons at Bank of America (BAC - Analyst Report).   

This shouldn’t be surprising.  While growing, the US economy’s projected 3Q growth rate is low.  And S&P 500 companies have larger international operations, which are hurt by the declining overseas situation and strong dollar.  This is simply not an environment where companies make money hand over fist; instead, they have to grind out incremental revenue gains and also engage in aggressive expense management.

     Last week, I made the following observation about the market:

The oil sector slowdown and strong dollar continue to provide slight headwinds.  But the core US “moderate” growth story remains.  The markets, however are still expensive.  And with a second consecutive quarter of weak revenue growth a distinct possibility, a solid and sustained upside move that eliminates recent losses seems difficult at best.     

I also noted that the market was “technically challenged,” with the SPYs, IJHs and IWMs forming an upward sloping wedge pattern.  These patterns typically form after a sell-off when traders begin to accumulate more attractively valued shares.   But these patterns are more likely to break to the downside, which the latest rising wedge did: 

Prices hit resistance at the 10 day EMA, then broke support provided by the trend line connecting late August/early September lows.  Prices are currently holding at the ~192.5 level.  All the other averages (the IWMs, IJHs and OEFs) did the exact same thing last week.     

Markets Conclusion: the markets remain in a difficult situation: they’re still expensive with little meaningful economic fuel to propel them higher.  Domestic economic growth may not be sufficient to provide meaningful revenue and earnings growth, damaging smaller companies.  The international situation isn’t much better, hurting larger companies.  Conversely, there is little threat of a recession.  The LEIs and CEIs continue to rise:

And while there has been slight weakness in the long leading indicators, there are no signs of a reversal.  In short, it appears the 2H15 will see slower growth, but no recession.

     In short, the markets will continue to meander. 





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