Weekly Wrap-up: On-trend Economic Growth
The following article was first published at The Agile Trader on Sunday, February 4, 2007.
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Last week the Advance Gross Domestic Product (GDP) numbers printed for 4Q06. (These numbers will be revised at the end of February and then again at the end of March.) Headline Real GDP growth was a tick above the trend of the past 3 years at +3.5% annualized, and was well above the consensus estimate of +3.1%. If we roll up our sleeves and dig into the numbers we see some interesting factoids.
This first table shows 4Q06's annualized percentage growth along with the 12-quarter median reading and width of 1 standard deviation (1SD) over the past 12 quarterly readings. (1SD measures the volatility of the series, telling us how wide a range from the median would include 68% of all cases. So, for instance Line 1 below, which printed at 3.5%, has a 12-quarter median of 3.4%. And it's likely that about 68% of the time it would print within 1% of that level, between 2.4% and 4.4%.)
I've highlighted in green and red respectively, all the readings that fall above and below 1SD from the median. So, green fields are unusually strong readings and red fields are unusually weak readings.
Real GDP (line 1) was a tick above the 12-quarter median. Personal Consumption (line 2) was somewhat strong...Consumption of Nondurable Goods (line 4) was notably stronger than the trend. Gross Private Domestic Investment (Line 6) was terribly weak, mainly on the sharp drop in Residential Investment.
Exports (13) were somewhat strong on sharp growth in Services Exports (16). Imports were well below the trend, mainly on a decline in Goods Imports (declining oil prices). And finally Government Spending (20) was elevated, most especially on a precipitous rise in Defense spending (22).
Soft landing? Hardly. Despite weakness in the Housing sector, the overall economy appears to be humming along on trend. Heck, last quarter wasn't even a trip into the slow lane!
Meanwhile, because the Implicit Price Deflator fell all the way to +1.5% (from 3Q's +1.9% and the elevated +3.3% readings of most of the prior year -- can you say falling oil prices?) Nominal GDP growth printed at +5%, smack on our forecast for the coming year. And that's a number that makes the 10-Yr Treasury Yield (TNX, now at 4.83%) look pretty close to rational. (Normally Nominal GDP and TNX are fairly close to one another).
The Core PCE Deflator, the Fed's favorite measure of inflation, decelerated a tick to +2.1%, just a tick above the top of their comfort range. So, it appears that there really is a modest waning of inflation pressures, despite overall strong resource utilization (tight capacity utilization and a robust jobs market) and stronger-than-expected real growth.
Our outlook for '07, which includes slowing earnings growth (profit margins should compress a bit) and a decline in Equity Risk Premium, as discussed last week, looks to be on track.
Trailing 52-Week Operating Earnings on the SPX are up 13.6% Y/Y as of Friday. Meanwhile Forward Operating Earnings are currently projected at +9.1% above Trailing Operating Earnings.
Quality of Earnings remains solid, with Reported EPS just -4.5% below Trailing Operating Earnings. (The gap between the yellow and pink lines remains narrow, meaning that there's not much accounting shenanigans being used on the Street.)
The projected slowdown in earnings continues to look to be of the constructive sort, as most of that slowdown is in the Energy sector.
While the trends in the other 9 sectors look clearly productive, the Energy sector is in a consolidation phase, caught between a line of rising lows (yellow arrow) and a line of descending highs (red arrow). And growth for the other 9 sectors is expected to outstrip growth in Energy earnings during the coming 12 months.
I would continue to suspect that aggregate SPX profit growth in the coming year will be less than is currently expected, as profit margins, which are already in the 99th percentile relative to the past 60 years, would have to expand still further to match profit-growth expectations in the context of trend-rate or below-trend GDP growth.
REVISITING THE 4-YEAR CYCLE
Our working assumption is that the new 4-year cycle in the stock market began on July 17. I have to hold my nose a little bit when I say that because normally the new cycle begins in the September-November time frame, but, as Peyton Manning will have to do this evening, we will have to take what the defense gives us, and in '06 it did not give us any autumn low from which to launch the new cycle.
If our launch date is close to correct, then we are about 137 trading days into the cycle, a point at which, based on the chart above, the market tends to flatten out and consolidate some of its early-cycle gains.
Indeed, the 6+ months of the cycle look likely to provide increased choppiness and decreased upside directional momentum
Note: While the current cycle is underperforming both the mean and median cycle, I believe that's more a function of having not provided a sizable pullback than of real underperformance.
With the above cyclical factors in mind, a look at a variety of stock indices and internal metrics augur bullish for the overall technical outlook. We are seeing bullish confirmations on the vast majority of these charts.
The SPX and the Dow Industrials both busted to new cyclical highs in late September. And at this point the S&P LargeCaps (OEX), MidCaps (MID), and the SmallCaps (RUT) have all confirmed those breakouts by themselves breaking to the upside.
The Dow Transports (DJ-20) are really the only question mark among these 6 charts. The Trannies are flirting with new highs, but have not definitively busted through.
Having said that, failures of these breakouts, especially in MidCaps and SmallCaps, which charts are vulnerable, could reverse the bullish implications of these confirmations.
Looking at market internals, both the NYSE Cumulative Volume and Advance/Decline Line have likewise bullishly confirmed.
Only the Nasdaq 100 Advance/Decline Line remains mired in a negative pattern, flirting with horizontal resistance and below its longer-term downtrend line. And this brings to light a not-insignificant negative divergence that bears watching.
While the Nasdaq Composite (COMPQX), the Nasdaq 100 (NDX), and the Amex Biotech Index (BTK) have broken above their spring highs, these upside breakouts are much less convincing and aggressive than their broad-market counterparts above (SPX, Dow, OEX).
Indeed, all the more speculative indices, including the Nasdaq brothers (COMPQX, NDX), the Biotechs (BTK), the MidCaps (MID), and the SmallCaps (RUT) are showing poor leadership characteristics, both internally and in their price patterns. And most especial among the speculative sectors that are lagging is the Semiconductors (SOX), which persists in leaving its leg stuck knee-deep in the mud down near the level of a 50% retracement of its '06 decline.
Is it possible that the speculative sectors will jump out and suddenly begin leading? Yes. If economic growth re-emerges, if Windows Vista is a big hit, spurring a PC replacement cycle. If, simultaneously, commodities prices and inflation drop sharply enough to put the Fed into a loosening mode. If, in short, a series of factors coalesce to squirt still more liquidity at the stock market.
However, more likely, the new 4-yr cycle is defining its properties and characteristics. And among those characteristics is over the past 2 months, leadership from these sectors:
Consumer Discretionary stocks, Health Care, Financials, Consumer Staples, and Materials.
And lollygagging was seen in these sectors: Utilities, Technology, Industrials, and Energy.
We'll look more closely at the various sectors of the SPX next week.
Have a great Superbowl!
Best regards and good trading!