Where Is The Stock Market Getting Its Marching Orders?

Equity investors are basking in a year in which stocks moved up smartly, steadily, recording a new high yesterday. The nagging question is: where is the stock market taking its cue to move higher? An overview of recent economic data in the US reveals an economy sliding, whether into recession or not, but nonetheless, not providing any substance as to why the equity markets continue to march forward. Major economic components reveal that:

National output has been steadily sliding from 3% in the first quarter to an expected 1% for the fourth quarter.

The productivity growth stalled badly as output slackened off and employers have yet to adjust their workforce to the decline in orders and sales, especially in manufacturing. Third-quarter labor productivity actually fell by 0.3% and, in turn, unit labor costs were up 3.6%. Both measures will impact negatively on corporate profits.

Retailers are hanging on by their fingertips as auto sales have fallen off and the talk among automakers focuses on ‘peak-car’ sales and the introduction of EVs to contend with climate change. September retail sales dropped by 0.3% as consumers walked away from buying building materials, online purchases and automobiles. There is a certain amount of anxiety going into the holiday season as recently introduced tariffs start to take full effect.

Business investment has fallen all year. After receiving the largest tax cut in recent memory, the corporate sector chose to distribute that largesse to shareholders rather than expand operations aided by new plant and equipment. The fall-off in business investment has been one of the most glaring failures in the economy to date.

Corporate profits as measured in the national accounts (GAAP measurements) have plateaued in 2016-17 and show no signs of increasing. In part, the weakness in profits is a big reason why capital expenditures have been poor.

External trade is clearly a victim of the senseless China-US trade war. The decline in US worldwide exports continues to be a drag on the overall economy. Despite the now on-again, now off-again, interim trade truce with China, the uncertainty is so pervasive that it affects all segments of the industrial sector.

Globally, there is clear evidence of excess supply in the face of faltering demand, leading to low inflation and possibly deflation in some sectors. Corporations will be hard-pressed to raise revenues in such an environment. Low long-term bonds yields testify to the disinflation that is currently taking hold everywhere.

So, much of the optimism in the stock market comes from the belief that the Fed will come to the rescue. One viewpoint argues that the three rate cuts this year will start to show positive results in 2020. Furthermore, the Fed continues with a QE program designed to provide more liquidity and support of commercial banks. Yet, at the same time, Fed officials are cautioning investors not to rely on monetary expansion to support the market. Not only are there fewer arrows left in the monetary quiver, but these arrows are less effective in a world already dominated by very low-interest rates.