Here’s Why Nothing Has Changed
Over the past two weeks, a fair amount of uncertainty has spread into the
equity investor’s psyche on the back of mixed economic data. However, cyclical
forces remain in tact and, in my view, the economic recovery will continue into
year-end, giving the equity markets further upside. Let me elaborate….
Although August’s economic data was admittedly anemic, the trend nevertheless
remains up. To be sure, business spending is now up 8.5% since last November;
while inventories have been declining. As a result, businesses will need to
produce additional goods in the months ahead in order to meet future demand and
replenish depleted inventories to normal levels. Â
 Additionally, the Conference Board Index of Leading Economic
Indicators, which has been a very accurate forward indicator for industrial
activity, has been up sequentially since April, suggesting that a meaningful
rebound in production is close at hand. As can be seen in the chart below, the
index has led production activity by six months and is now at levels not seen
since August 2002. At the same time, industrial production only recently started
to turn up.Â
Due to the factors mentioned above GDP growth is now expected to rise above
4% for the remainder of the year. In fact, today Dallas Federal Reserve
President McTeer predicted such a scenario for the fourth quarter, and judging
by dramatic rise in Treasury yields, the market certainly agrees with this
assessment. Most importantly though, should the economy rise above 4%, jobs will
be created since economic growth will exceed productivity growth (which has been
blamed for the “jobless recovery” thus far).
Lastly, forward earnings are now up sequentially for the past 26 weeks and
the ratio of negative to positive earnings has dropped to 20% this quarter. As
evidenced in the chart below, forward earnings have been a pretty accurate
indicator of S&P 500 performance.
