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.
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