The stock market is all about expectations

The stock market has rallied strongly since March. Why has the market rebounded in the face of weak economic data? The reason: because the market is all about expectations.

The stock market is a reflection of investor expectations about future economic profits. When investors expect economic conditions to improve and companies to make growing profits, the stock market tends to go up.

Recent economic reports do not show a growing economy, but they do show that the economy is declining less quickly. Why is that a good thing? Think about an airplane in a nosedive. Before it starts to climb again, it’s rate of descent needs to slow. Then it levels off before it climbs. The rate of descent must get less bad before leveling or climbing can occur. Same with the economy.

The market has rallied since March not because economic data or profits have grown, but because things are getting bad less quickly. If it turns out that profits level off at a low level, keep declining slowly, or climb at a slower rate than people expect, the market will decline. In other words, the market will decline if economic growth and company profits don’t meet or exceed investors’ current expectations.

How likely is it that economic growth and company profits will miss, meet or exceed expectations? I have no idea, but in the short run that’s the $64,000 question. If you invest long term, pick good investments, and pay the right price, you don’t need to guess this outcome.

But, it’s an interesting question to ask. Do you expect strong economic growth over the next year? Do you think consumers are ready to start spending again despite 10%+ unemployment? Do you think recent government efforts to spur economic growth will work? Do you think company profitability will rebound by around 50% like the market is expecting?

After listening to conference calls over the last 3 weeks, I have to admit to having an opinion (for what that’s worth). Almost every company I’ve listened to has beat profit expectations by cutting costs and missed expectations in terms of sales. In other words, they are missing expectations for selling products, but meeting profit expectations by firing people and not spending for future growth. That doesn’t sound sustainable to me.

The market seems to be basking in the glow of potential, not actual growth. If that growth turns out to be ephemeral, look out below!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Recession seems imminent

More troubling economic news this week.

First, the Institute for Supply Management reported that it’s manufacturing survey index showed a contracting industrial sector. Any reading below 50 means contraction. The reading was 47.7 last month. The last time it was this low was in April 2003, coming out of the last recession. Readings below 45 usually indicate a recession is occurring. We’re not there, yet, but we seem to be on the way.

Next, residential construction spending showed a 2.5% decline in November. The housing market is dropping, that’s no surprise. But, it’s impact on the economy as a whole still seems under-acknowledged.

Then, initial jobless claims fell 21,000, but the 4-week moving average, which better indicates labor market trends, was up to 343,750. This number is usually up around 400,000 in a recession, meaning we may not be there, yet. The last time the 4-week moving average was this high was in the summer of 2004, during the slow recovery from the previous recession.

Next, shipments of factory goods excluding petroleum and coal showed its fourth decline in 6 months. This indicates that, other than higher energy costs, shipments of factory goods is in a downward trend.

Today, payroll employment came out at +18,000 jobs. That may sound good, but a large part of that number is based on assumptions about jobs being created by small companies. Large revisions in this number are normal, especially at turning points in the economic cycle.

The payroll employment report was accompanied by a report of the civilian unemployment rate at 5.0%. Unemployment hit a cycle low of 4.4% just last March. When the civilian unemployment rate rises from its cycle low to 0.4% above that rate, a recession is usually imminent. 5.0% is 0.6% above 4.4%.

The stock market finally seems to be noticing with the S&P 500 down over 10% from the recent all-time high it hit last October. Although a 10% drop may not seem bad, recessions frequently cause 40% declines in the stock market.

It’s not all doom and gloom, though. Although the economy may be rolling over into a recession, this is a normal part of the business cycle. As long as our government doesn’t do stupid things to try to “solve” this “problem,” we will soon see an upswing in the market and economy.

Usually, the stock market drops long before the economy does. This time, it seems a little behind schedule. Despite this, the stock market also tends to lead the economy as we come out of a recession. Considering that most recessions don’t last more than a few quarters, this could very well mean the stock market could end up for the year.

That means this year could very well be an excellent year for bargain hunting!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.