Stock Market Up, Economy Down?

96% of S&P 500's Gains Packed in 10 Trading Days

Jul 26, 2023

S&P 500's Remarkable Rebound

The financial markets have been experiencing a significant rebound, with the S&P 500 index registering an increase of over 19% since the beginning of the year. This nearly reverses the previous year's decline of 19.4%. Tech stocks, such as Tesla, Nvidia, Meta Platforms, Apple, Microsoft, Alphabet, and Amazon, have played a crucial role in driving the market's gains in 2023. DataTrek Research highlights that the 10 best trading days of 2023 have accounted for 96% of the S&P 500's year-to-date gains. In fact, out of the 137 trading days, there have been only 11 more up days than down days. Last year, the bear-market losses were also concentrated in just 5 trading days. This emphasizes the narrow margin between positive and negative performance for the index.

The Upcoming Week

The global stock market is poised for a critical week as companies with a combined market value of $27 trillion prepare to release their quarterly earnings reports. The anticipation is high for these companies to deliver positive results, as recent market reactions to disappointing earnings have shown. Investors are becoming increasingly difficult to impress, as evidenced by the fact that only 42% of S&P 500 stocks had a positive post-earnings reaction in the previous quarter, despite beating estimates at an above-average rate.

The recent earnings reports from Netflix and Tesla serve as a reminder of how markets can react to earnings shortfalls or guidance concerns. Both companies experienced significant declines in their stock prices after reporting weaker-than-expected results. This triggered a broader selloff that wiped out over $400 billion from the Nasdaq 100's market capitalization in a single day.

Prior to the earnings season, investors were optimistic about central banks halting interest rate hikes and the US economy avoiding a contraction. This optimism had driven the MSCI All-Country World Index to year-to-date gains of over 15%. The S&P 500, trading at almost 20 times forward earnings, was also at a premium to its long-term price valuation.

While some strategists argue that the S&P 500's high valuation is reasonable and could continue to rise as laggards in the index catch up with winners in artificial intelligence, others caution that the market may require more confirmation of an upturn in growth to sustain current valuations. As earnings reports roll in this week, investors will closely scrutinize the results and guidance provided by companies to determine the future direction of global stocks.

Buyers in this market seem undeterred by the Federal Reserve's plan to raise interest rates by a quarter of a percentage point. The surprising speed at which the bearish sentiment from earlier this year has dissipated is noteworthy, considering concerns about high inflation and the fear of a recession. Despite the overall positive performance of the market, there are some indications that it may be time to take profits. Leading indicators suggest that economic growth may remain soft.

Economic Indicators Point Down

Inflation

Inflation currently stands at 3%, down from a high of 9.1% last year. While this decrease may seem positive at first glance, core inflation is running at 4.8%, well above the Federal Reserve's target of 2%. This discrepancy suggests that the cost of goods and services essential for everyday life is increasing at a rate that outpaces general inflation, potentially straining household budgets.

Business Activity

In the US, business optimism about the future has declined. The purchasing managers index (PMI) score of 48.9, which indicates whether business activity is expanding or shrinking, reached an eight-month low. This decline was driven by worse-than-expected declines in both manufacturing and services sectors.

Leading Indicators Index & Yield Inversion

The leading indicators index has experienced 15 consecutive months of decline, which historically has resulted in an economic slowdown. This trend aligns with the inverted yield curve, which has been a reliable predictor of recessions for almost a year. The yield curve inverts when long-term debt instruments have a lower yield than short-term debt instruments, which is often seen as a sign of an upcoming recession.

U.S. Oil

The oilfield services industry in the US is experiencing a slowdown due to companies reducing oil and gas drilling. This has resulted in decreased fracking activity and increased availability in the calendar for oilfield services providers. The decrease in activity is evident in America's energy heartlands, which span from west Texas to North Dakota. The number of rigs and frack crews in the field has been consistently declining since late last year. As a result, equipment has been sold at discounted prices, and sentiment within the industry is reported to be at its weakest since the depths of the coronavirus pandemic.

Consumer Spending

There are signs that U.S. consumer spending may be starting to slow down. The latest same-store sales year-over-year figure from Johnson Redbooks has turned negative, indicating a decline in purchases compared to the previous year. If this trend continues, it suggests that consumers are spending less overall, increasing the likelihood of a recession. Same-store sales figures are used to measure revenue growth from existing store locations. A negative year-over-year figure indicates that sales have decreased compared to the same period in the previous year.

U.S. Debt, Money & The Fed

Another significant concern is the rising interest expense of the U.S. government. The government's interest expense now accounts for 19.3% of its receipts, up from 13.5% a year ago. The national debt has reached $31.5 trillion, which is 1.2 times the size of the gross national product. The average maturity of this debt is 5.2 years, meaning that approximately $750 billion needs to be refinanced each quarter. As a result, interest rates on newly issued notes and bonds have risen to 3.8% to 5.5%, compared to the approximately 1.9% paid on outstanding debt.

The U.S. economy's heavy reliance on credit and its sustenance on low interest rates for an extended period are also factors to consider. The Federal Reserve's tightening policy will have a lagging effect on the economy. Interest rates have been raised from near zero to over 5% in just 15 months, and the decline in the common measure of money supply, M2, is the largest since its formal tracking began in 1959. Those who believe in a soft landing without a recession may find themselves proven wrong.

Labor Market

Despite firms in both manufacturing and services increasing their workforce headcount in July, the rate of job creation was at a six-month low. This suggests a cooling in the job market, which could be a sign of economic slowdown. Domestic demand has also been subdued with new orders weakening for the second straight month. The overall future outlook fell to its lowest levels since December 2022.

The unemployment rate is another lagging indicator that does not always accurately reflect economic conditions. Companies have been hesitant to lay off workers due to fears of struggling to find qualified employees in the next cycle. This has led to companies reducing hours instead of laying off workers. Therefore, it is crucial to look beyond just unemployment and consider the number of hours worked.

Jobless claims fell to 228,000 in the most recent week. This figure may suggest that the labor market is not showing durable signs of a cooling economy. However, it's crucial to consider that jobless claims only reflect the number of people who are actively seeking employment benefits. It does not account for those who have stopped looking for work or those who are underemployed.

Economic Disconnect

Despite the impressive 19% surge in the S&P 500 since the beginning of the year, there is a growing disconnect between the stock market's performance and underlying economic indicators. Economic signals, such as inflation, business activity, and the leading indicators index, indicate potential challenges. Additionally, factors like the U.S. oil industry slowdown, weakening consumer spending, rising government debt, and the Federal Reserve's tightening policy add complexity to the economic landscape. While the labor market shows some positive signs, the cooling job creation rate and subdued domestic demand suggest the possibility of an economic slowdown. The stock market's focus on short-term gains, driven by momentum, fund flows, sentiment, and technical factors, may not always accurately reflect the true state of the economy, revealing a disparity between market optimism and economic reality.

For more analysis on these topics, check out these articles:

Thanks For Reading!

If you find value in this newsletter and want to make sure you don't miss any important updates, you should definitely consider subscribing. By subscribing, you'll be the first to know about new articles and special offers.

If you have any newsletters you wish to see in our lineup, please reach out and let us know. We will continually look to incorporate more sources to our weekly wrap-up.

American Economy Daily

Discussion about this post