Something To Think About, Eh?

The worst news of the day so far is the further economic contraction in Europe. The two powerhouses of France and German both saw a slide backwards with France actually dipping below the negative line. This is not good news, nor is it unexpected. The now annual spring swoon not only affects the US and Chinese economies; Europe is a part of the game as well. Look to the fourth quarter for signs of Europe’s continued economic malaise or its nascent recovery. In the meantime, money is moving on the continent.

Activity in Europe’s initial public offering (IPO) market is picking up and will drive economic recovery across the region, the CEO of the London Stock Exchange (LSE) told CNBC on Wednesday.

The market here, however, does not seem to care about the negative backslide in Europe. It seems content to keep doing what it is doing, which is recording record high after record high. The negative chatter about this reality has diminished, but one would think the economic data that came out this morning would motivate the market to take a step backward. So far, it has not.

A report showed manufacturing activity in New York state unexpectedly contracted in May as new orders and shipments of finished goods fell. The New York Federal Reserve’s “Empire State” general business conditions index fell to minus 1.43 this month from 3.05 in April. Economists had expected the index to rise to 4.

The reason the market might not care much about the above is that it understands the spring swoon scenario and it understands that factory production is cyclical in nature. The market knows that as long as consumer demand remains in force, factories will move back into production. So far this year, the consumer has stayed in the game, and with the next bit of news, the likelihood is strong that consumer demand will continue.

Producer prices recorded their largest drop in three years in April as gasoline and food costs tumbled.

No inflation, slight deflation, means less money going to pay the bills and more money in the pocket to spend. The market understands this simple reality, and it understands that as long as inflation is in check, the Fed has no reason to up and skedaddle, which is quite contrary to yesterday when the WSJ prepared the market for the exit of the Fed. How’s that for a “please all” scenario? Are we now looking toward 16,000 for the DIJA and 1750 for the S&P?

In one fell swoop, the non-partisan budget referee slashed its deficit forecast for the current fiscal year by $203 billion from estimates made in February to $642 billion – making it the smallest budget shortfall since 2008.

The above news supports the notion of a higher Dow and S&P. The market is bound to like the news of a shrinking budget deficit, despite the predictable response from the ultra-budget hawks – yeh, but entitlement programs will bust the budget soon enough, blah, blah, blah … Keep in mind, as the deficit shrinks, the less likely it is the Republicans can or will create another debt-ceiling crisis.

No matter how one slices the US economic and fiscal pie, the fact is the market likes the way the pie looks – things are improving.

A rising stock market, rising Treasury yields and a firming dollar seems like an abnormal trading relationship post-financial crisis, but the recent correlation between these markets may be signaling more confidence in the U.S. and more ‘normal’ times ahead.

Sheesh! I have no clue about “normal” anymore. Since 2008, the world has changed and the market has changed. What we once knew is no longer, and that will be the case for some time to come, as we move through the “Great Transformation.” So, we accept and exist in the new normal. Resistance is futile and energy sapping.

Stocks have a little extra bragging room now over bonds: an earnings yield on the Standard & Poor’s 500 has just hit a 58-year high. While the 5.4 percent earnings yield-the inverse of the price-to-earnings ratio-is still considerably below its historical average, the number is nearly triple the 1.9 percent yield of the 10-year Treasury note.
Investors use the yields generally and this ratio in particular to determine how much reward they are getting for their risk. A low S&P 500 earnings yield, then, would suggest a market that is at or approaching expensive levels.

Since, the earnings yield on the S&P 500 is at a 58-year high, that would suggest there’s still room to move up toward those lofty levels I mentioned a moment ago. Do you remember back in January when many floated the idea of the “Great Rotation,” money moving from bonds to equities and commodities? Well, if the market momentum continues, the earnings yield just might be the catalyst that actuates what then was just talk.