The week ahead will be an extremely busy one for financial markets with a GDP report, a jobs report and 104 S&P500 companies scheduled to release earnings.
-David Kelly, chief global strategist, JP Morgan Funds
The RV Rally
The week ahead will be an extremely busy one for financial markets with a GDP report, a jobs report and 104 S&P500 companies scheduled to release earnings. Analyst estimates for these specific numbers along with overall assessments of the macro-economic climate will, to some extent, be colored by an extremely good start to the year for the stock market. As of Friday, the S&P500 was up 5.4% for the year, breaching the 1,500 mark for the first time in over five years. Investors, seeing a rising market, often assume it is telling them something profound about the economy.
In this case, it isn’t – as will likely be borne out by numbers this week. There will be some bright spots: Durable Goods Orders on Monday should see a solid gain on the back of stronger aircraft orders while Pending Home Sales and the Case-Shiller Price Indices should confirm the solid housing rebound. However, manufacturing data from
Chicago on Thursday and the national Markit and ISM surveys on Friday should be less optimistic than last week’s flash Markit numbers. Consumer Confidence from the Conference Board on Tuesday and the University of Michigan on Friday may show a little more gloom than is being felt on Wall Street this week as most Americans are (by now) more aware of the impact of the payroll tax hike on their paychecks than the recently strong stock market. Light Vehicle Sales due out on Friday could show a small decline from December.
Most important, it now appears that real GDP growth for the fourth quarter may have been less than 1%. This is significant because this weakness occurred before the impact of fiscal drag this quarter. Recently job numbers have looked better. However, it is very hard for employment to sustain good growth in the absence of strong demand. We expect Payrolls will have grown by more than 100,000 in January but there is a risk of a weaker-than-expected number.
But if equity markets are not reflecting a stronger economy, why are they rising? One simple explanation is the conflict between relative valuation and uncertainty. The Fed’s extraordinarily easy monetary policy (which should be reaffirmed in the FOMC meeting this week) combined with the voracious appetite of investors for bonds has driven yields so low that in relative terms stocks still look very cheap. Investors have been hesitant to take advantage of this for years because of worries about Europe, the U.S. budget deficit, the China slowdown, oil price spikes or the potential for a collapse in margins. As these threats have receded and as the pain of the big market crashes of the 2000s have faded, investors are more willing to embrace stocks. Indeed the first two full weeks of January saw almost $13 billion net go into domestic equity funds, a stronger inflow than has been seen in any full month in almost four years.
This trend may well continue. But it is important to recognize that this is a rally based on relative valuations rather than improving fundamentals and investors will still need to keep a close eye on those fundamentals in the months ahead.