As if we needed a reminder, the market's wild ride last
week highlighted just how much punch economic indicators can
pack.
Thursday's GDP report -- which showed surprisingly strong
growth -- put the brakes on early week declines and sent the
S&P 500 index shooting up 2.3%. The celebration was
short-lived, though, as Friday's reports on personal income,
personal spending, and consumer sentiment had investors
giving back Thursday's gains and then some.
The manic swings on Thursday and Friday may scream
"economic confusion," but I don't think it's the economy
that's standing between the market and a continuation of the
recent rally.
The first half of the equation
When the GDP report came out last week, my Foolish
colleague Morgan Housel
rightly arguedthat the 3.5% uptick wasn't all it was
cracked up to be. Government programs -- most notably Cash
for Clunkers -- had a big hand in boosting third-quarter
output, and that's "help" that won't be there in future
quarters.
However, even if we strip out the 1.66 percentage points
that autos added to third-quarter GDP, we come up with 1.8%
growth. Sure, that's significantly lower, but it's still a
breath of fresh air when we consider GDP growth over the
preceding six quarters:
Quarter
Growth
Q1 2008
(0.7%)
Q2 2008
1.5%
Q3 2008
(2.7%)
Q4 2008
(5.4%)
Q1 2009
(6.4%)
Q2 2009
(0.7%)
Source: BEA.gov.
Going beyond GDP, there are plenty of reasons to be
suspicious of economic recovery. The unemployment report at
the end of the week is expected to show that the unemployment
rate ticked up to 9.9% in October. Banks like
Citigroup (NYSE: C) are still seen as shaky,
and mortgage lenders
Fannie Mae (NYSE: FNM) and
Freddie Mac are
downright frightful. And amid all of this, the personal
income and spending data released last week show that
consumers are still getting crunched.
My fellow Fool Dan Caplinger
countered this broader pessimismby highlighting the
difference between leading economic indicators and lagging
ones. Back in September, I shined a similar light on
the unemployment rate. And, in fact, if we scope out the
view from a longer timeline, we can see that there are a
number of major economic indicators that are looking much
healthier than they did earlier this year:
Indicator
February 2007
February 2009
Most Recent
Institute for Supply Management's Manufacturing
PMI
52.3%
35.8%
55.7%
Initial Unemployment Claims
307,000
617,000
527,000
Month-to-Month Change in Payrolls -- ADP
Employment Report
95,000
(681,000)
(254,000)
Reuters/University of Michigan Index of Consumer
Sentiment
91.3
56.3
70.6
Sources: The Institute of Supply
Management, the U.S. Department of Labor, ADP, the
University of Michigan.
Initial unemployment claims are as of the first week
of each month, except most recent.
While we clearly still have a lot of ground to make up --
particularly on the employment side -- the numbers show that
the economy is in much better shape than earlier this
year.
In short, it may not be the economy that investors have to
worry about.
So this is good news, right?
There's certainly good reason to have more optimism
when the economy is in recovery mode, but the condition of
the economy is only half the picture. The other half is
looking at the valuation of a given stock or the market as a
whole and considering that in the context of the current
economic environment.
As I've noted on a few occasions,
the rally that we've been ridingsince early March has
ratcheted up the market's overall valuation to the point
where it's not particularly attractive. Based on Standard
& Poor's estimates, the S&P 500 index is currently
trading at a forward price-to-earnings ratio of over 24.
While earnings may benefit from an improving economy, you're
still paying a hefty price for that index.
In other words, we may see the overall market falter even
if the economy continues to improve. Continued... |