The disconnect between the stock market and the U.S.economy continues to grow, as the key stock indices run way ahead of reality.
The fundamental reasons behind the rise in today’s key stock indices are missing. For a real rally to happen, there has to be rising demand in the U.S. economy, consumers must be confident to spend, and businesses should see their sales rising. None of this is taking place.
Industrial production in the U.S. economy decreased 0.5% in April—marking the second decline since the beginning of the year. (Source: Federal Reserve, May 15, 2013.)
Similarly, manufacturing in the U.S. economy is also portraying a bleak picture of demand. Manufacturing output in the U.S. economy declined 0.4% in April after continuing its slump from March, when it decreased by 0.3%.
In the first quarter, a large number of companies on the key stock indices, like the S&P 500, were able to show better-than-expected corporate earnings. But in hindsight, they showed one troubling phenomenon: as the majority of the companies on the S&P 500 have already reported their corporate earnings, only 48% of them were able to beat revenue expectations. (Source: FactSet, May 10, 2013.)
Looking ahead, the picture for the key stock indices in the U.S. economy doesn’t look bright. For example, as of May 10, out of all the companies on the S&P 500 that have issued their corporate earnings guidance, more than 79% of them have issued a negative outlook. The estimated earnings growth rate for companies on the S&P 500 stands at 1.6%, compared to 4.5% near the end of March.
On top of all these troubles in the U.S. economy, the global economy is weakening, as major economic hubs are begging for growth. Look at China, for example. The country is expected to move at a very slow rate this year. Japan is in a recession. The eurozone just announced it has now completed six quarters of negative gross domestic product (GDP).
As a result of all these negative factors, companies on the key stock indices will eventually suffer—and suffer big. During an economic slowdown, consumers buy less and hoard what they have, because they are uncertain about their future. So companies don’t really sell more and their profitably decreases and, obviously, this is priced into the key stock indices.
In the first quarter of this year and the last quarter of 2012, we saw an unprecedented increase in share buyback activity from companies in the U.S. economy. Some of the most notable corporate names in history bought back their shares—all this does is increase the earnings ratio without really increasing the profit.
I continue to be skeptical as the key stock indices move higher. Right now, it seems as if investors are looking for reasons to buy no matter what. Unfortunately, optimism is the stock market’s worst friend.
In the first quarter of 2013, the eurozone continued to witness an economic contraction. The gross domestic product (GDP) of the 17-nation region declined 0.2%. This decrease in the GDP marked the sixth straight quarter of economic contraction in the eurozone and the longest since 1995. (Source: Reuters, May 15, 2013.)
The debt-infested countries in the eurozone, such as Greece, Spain, Italy, and Portugal, are already experiencing severe economic contraction; and to say the very least, they have a lot of issues to resolve before they even come close to seeing any economic growth.
What concerns me the most is that the stronger nations in the eurozone are starting to show weakness—the economic slowdown is picking up speed. It could make the economic contraction in the entire region much more severe and could send the eurozone into another downward spiral.
Consider the French economy—the second-biggest economic hub in the eurozone. In the first quarter of 2013, France witnessed an economic contraction—GDP declined 0.2% and France entered a recession. (Source: Bloomberg, May 15, 2013.) For the past few quarters, France’s economy has been witnessing severe pressures, and unemployment in the country continues to be a major problem.
Similarly, Germany—the biggest nation in eurozone by GDP—grew at a dismal pace in the first quarter of 2013, below economists’ estimates. The German Federal Statistical office reported that the German economy grew 0.1% in the first quarter, and the revised calculation showed the country experienced an economic contraction in the last quarter of 2012, when its GDP declined by 0.7%. (Source: Destatis, May 15, 2013.) But there are even more troubling statistics; looking at it from a year-on-year basis, Germany’s GDP declined by 1.4% in the first quarter of 2013.
All of this shouldn’t come as a surprise to the readers of Profit Confidential; I have been harping on about more economic contraction in the eurozone for some time now. All the pieces of the puzzle are just falling into place.
Dear reader, the troubles in the eurozone are important to observe, because the region as a whole can create a significant amount of demand in the global economy. If the area struggles further, it will weigh heavily on global trade. More specifically, major U.S.-based companies that operate in the eurozone will see their profitability decline.
What He Said:
“I’ve been writing to my readers for the past two years claiming the decline in the U.S. property market would not be the soft landing most analysts were expecting, but rather a hard landing. My view remains unchanged. The U.S. housing bust will be cut deeper and harder than most can realize today.” Michael Lombardi in Profit Confidential, June 13, 2007. While the popular media was predicting a bottoming of the real estate market in 2007, Michael was preparing his readers for worse times ahead.