The Economic/Market Disconnect

 

Here’s Bespoke Investment Group on today’s economic indicators and the market’s reaction:

While Markit PMI beat, auto sales soared, and construction spending came in very strong, the market was much more focused on a weak ISM Manufacturing number, which came in at 50.2 versus 50.6 expected. We don’t know what to tell you. The manufacturing sector is charitably 12% of GDP, and with auto sales purring, it’s hard to believe a pending contraction driven by domestic durable goods demand is afoot. That said, the market is the market, and despite an acceleration in US consumer and service sector indicators in 2015, it continues to believe that the rest of the world is more important. This is true across asset classes; credit spreads (investment grade and high yield both weak today), equities (major indices hitting their lows in the wake of the weak ISM figure), and Treasuries (ten year yields flat on the day, rising slightly off their lows immediately following ISM) all voted that the weak data representing a small sector of the economy was more important than the strong data representing a much larger chunk of it. Oil pulled the same trick, soaring into 10:00 AM before collapsing to close at the lows. Finally in currencies it was a rip-snorting rally in NOK (USDNOK –1.04%) that was the only bright spot as no other major currency moved more than 35 bps.

It’s possible that we’re seeing a fundamental divergence between financial assets and the US economy. Indeed, there are many signs (confidence, domestic versus international, stocks versus data, selloffs on a lack of tightening news from the FOMC) that suggest this is true. After years of asset price stimulation via QE, growth may meet prices in the middle. From where we sit, it’s almost impossible to see where constant talk of US recession is coming from; it’s certainly not founded in the fundamentals of the US economic data that we evaluate.

Here’s The Bank For International Settlements explaining why at times one bit of bad news can have the market diverging from the macroeconomic fundamentals:

Bad news in a market situation where investor risk appetite is already low is likely to result in a much greater repricing of risky assets than in periods where it is high. The dynamic stance of the risk appetite of market participants as a sentiment could thus serve as an important contributing factor in the transmission of shocks through the financial system. Furthermore, as it might itself be influenced by the situation in financial markets, it could work as a multiplier. Accordingly, taking into account the risk appetite/ risk aversion of investors and its evolution has become an important element of assessing the condition and stability of financial markets.

Here, according to Martin Pring in The All Season Investor, is why poor sentiment—beyond the potential reflex action noted above—is generally a bullish sign for stocks. Particularly when the economic backdrop is sound:

Market tops take longer to form and are more subtle. They usually develop under an extremely favorable news background. Economic experts are typically forecasting a rosy economy for as far as the eye can see. Analysts will be revising their forecasts upward to levels previously deemed ridiculous but that are now taken seriously.

Clearly, that would not describe today’s prevailing sentiment…

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