The stock market’s strong performance this summer surprised a lot of investment managers on Wall Street. Somehow, investor sentiment turned just enough to overtake reduced earnings outlooks for the third quarter. With some calm this summer regarding the sovereign debt crisis in the eurozone, investors bid on the stock market in the hope that the Federal Reserve would employ more monetary stimulus to help the U.S. economy. The stock market just might get what it wants. Recent data on U.S. manufacturing activity was very uninspiring and revealed a declining trend over the last several months, which is the real worry.
I still feel that the stock market is in a long process of topping out, and there are signs of this happening right now. The non-confirmation from the Dow Jones Transportation Index continues and stock market leadership in the NASDAQ is heavily weighted to Apple Inc. (NASDAQ/AAPL) and Google Inc. (NASDAQ/GOOG). Along with a few other technology companies, only a handful of names are carrying the NASDAQ.
Currently, lots of blue-chip companies that pay dividends are trading right at their 52-week highs and rightly so; institutional investors have needed to make these safe bets. (See “Who Benefits in an Economy and Stock Market Like Today’s?”) But, it’s very difficult to imagine the U.S. economy taking off and corporate revenue growth accelerating into 2013 in an age of market-imposed fiscal austerity. Capital markets around the world are forcing mature, debt-ridden economies to impose austerity measures, and the time has come for major fiscal prudence in the U.S. Accordingly, economic growth is going to be a very difficult thing to achieve in the near future.
While the stock market is not expensively priced, the earnings component of the price-to-earnings multiple is likely to get hit going into 2013. If current stock market leaders turn downward in price, then the rest of the stock market will be in trouble. Right now, your two best stock market indicators are probably Apple and the spot price of oil.
Nothing big is likely to happen to the equity market until the Federal Open Market Committee (FOMC) meeting next week. Oddly, bad news on the U.S. economy is a near-term positive for the stock market, as it increases pressure on the Federal Reserve to take new action.
There are lots of contradictions in the U.S. economy. Auto sales are on a surprising upswing, and according to auto executives, strength in new truck sales is the result of recovery in the housing market. Yet at the same time, both U.S. and eurozone manufacturing contracted in August, according to the data. So, just like the stock market, the U.S. economy is experiencing a choppy, almost trendless environment.
Practically, the Federal Reserve can’t really do more to help the U.S. economy in the short term. The central bank continues to increase the money supply at a furious pace in the hope of reflating the U.S. economy. Any new policy action by the Federal Reserve will help near-term investor sentiment, but won’t do anything to help general employment or manufacturing activity. At the end of the day, the U.S. economy is still in the process of recovering from the last business cycle, which produced a lot of excesses. Another recession in the U.S. economy before a new upward business cycle is likely.