Bewildering to bulls and bears alike: Despite the persistent private economy slack, many economic data points are downright V-shaped. Coincident indicators with a high signal value like the ISM surveys reflect the likely middle case, weak (0-3% real GDP) economic growth.
This doesn’t mean that earnings can’t continue to improve, or that stocks can’t go up. This environment likely commands a shallower premium on the earnings due to the perceived macro risks, but the stock market ultimately is an earnings discount machine at the end of the day. Valuations are very modest (the S&P 500 closed 13x the pessimistic forecast of $95 FY 2011 EPS), and expectations are low.
Conor Sen makes the valid argument that earnings can continue to grow with near-zero real GDP. This is particularly so if nominal GDP is more positive. (I’ve heard the argument that this inflation is margin compressing, but this is actually wrong: the inflation caused by resource inflation is largely subtracted from GDP with imports. The spread between nominal GDP and real GDP is going somewhere domestically, and it’s not going to wages, it’s going to corporate profits.) They improve earnings with buybacks (sometimes finances with extremely cheap borrowing), foreign earnings and foreign exchange gains.
Finally, seasonality plays a role: the bar, set by years of higher trend rate growth, is set too high during certain times of the year, and too low during others. The stock market has been baited by this for the past two years. That pressure is about to be somewhat relieved:
The Non-Manufacturing ISM NMI shows, with reasonable signal value, the relationship broadly between equities and the economy. Furthermore, it may have some leading qualities near turning points when the market may be discounting for a continuation of previous trends:
The Non-Manufacturing ISM Employment Index certainly does have a strong relationship with month/month changes in payrolls (and it’s presently commensurate to about 100k growth):
The Manufacturer’s Shipments, Inventories and Orders Survey from the Dept of Commerce simply show a V-shaped recovery in every series, with many getting close to eclipsing their previous pre-bust highs. Take New Orders of Non-Defence Capital Goods Excluding Aircraft:
Download this gallery (ZIP, null KB) Or even potentially more importantly, consumer goods (the end-generator of all demand):
The durable goods provide for two interesting observations:
- At such depressed levels, it’s almost all upside from here (much like homebuilding)
- It has a strong leading relationship with the economy, and despite the somewhat noisy series, is in a strong recovering up-trend
Finally, the Chicago Federal Reserve’s National Financial Conditions Index shows its lowest level of stress post-bust:
Perhaps things aren’t that bad. Or that good, either. Our playbook leans toward buying around 12-13x FY EPS, and selling at 14-15x — a play on the continuing middle case.