If the S&P 500 Index is trading close to the 1,400 level, then I view the equity market as being in good shape. We’re getting a bit of a consolidation now and this is completely normal after the flurry of corporate earnings from large-cap companies. Many smaller companies are only now beginning to report their earnings reports, but this is an equity market that’s focused on large-caps. They have been and I believe will continue to be the outperformers this year. (See Benchmark Stocks Reporting Great Earnings—But the Stock Market Bet on this Already.)
Institutional investors are waiting for a new catalyst to invest in this stock market; without one, the equity market will drift. There is a normal lull in share prices after an earnings season and it’s because the corporate news is over and share prices rose in anticipation of the numbers. Why buy a stock after it reports numbers the Street was looking for? I still believe that investors don’t have to be in any rush to consider new positions in the current environment. If we got a major correction in the equity market, then I’d say add to existing positions. Overall, though, I expect the stock market to become very vulnerable around the time of the U.S. election and going into next year. I could be wrong on this, but I don’t see economic growth accelerating much more than its current rate.
The U.S. economy and the stock market can move forward just fine in a slower growth environment. We just don’t want to see contraction in gross domestic product (GDP) and that’s why the Federal Reserve is doing everything it can (rightly or wrongly) to try to reinflate the economy. The equity market can handle declining rates of growth, but it can’t handle actual contraction in GDP. Because the stock market is fairly valued, this gives stocks a lot of leverage to handle bad news. I think the economy is moving in the right direction, but, just like in industry, it’s doing so in a choppy, uneven fashion.
I would say that the recent batch of economic news is signaling a slowing down in economic activity from the first quarter. The stock market is actually digesting this news quite well and buyers are coming back to the equity market even after disappointing news. But what the current economic news supports in my view are declining expectations for the future—in GDP and corporate earnings and for the stock market. Accordingly, I wouldn’t be surprised if Street analysts were to revise earnings outlooks lower for the bottom half of the year.