Last Wednesday the U.S. Commerce Department reported that Gross Domestic Product, or GDP, grew at an anemic annualized rate of only 0.2% in the month of March, contributing to a stock market sell-off later in the week. It doesn’t take much to spook the market these days, but in this case the GDP figure appears to have been distorted by a couple of singular events that should not be extrapolated over an entire year as they are not likely to reoccur.
This winter’s record cold weather strongly impacted consumer behavior in the densely populated northeast, where it was difficult for consumers to go about their normal buying routines when simply getting the car out of the driveway was not always possible. While certain purchases may have been delayed into the next month, others such as dining out or impulse shopping at the mall cannot be made up for at a later date.
And the protracted work stoppage at our West Coast ports prevented commerce in a number of critical industries from being consummated, as millions of tons of imports and exports sat paralyzed until the strike was settled. Much of that commerce cannot be recaptured in future months, but now that it has resumed it cannot negatively impact future results, either.
Meanwhile, the labor force participation rate remained virtually unchanged at 62.7% while hourly wages rose 0.3% in March, suggesting that the big drop in GDP was not due to a sudden decline in discretionary income in consumers’ pockets. At the same the U.S. dollar was retreating from its recent highs, which will make it easier for American manufacturers to sell their goods abroad in the months ahead.
In short, it appears investors chose to focus on the one data point that paints the least attractive picture of the U.S. economy, even if it was tainted by a unique set of circumstances. In and of itself that is cause for concern, as the final stages of a bull market are fueled by unbridled optimism while bear markets are usually sparked by a spate of nervous pessimism.
However, if the stock market is looking for a “wall of worry” to climb then the GDP figure provides a handy ladder, but in all likelihood next month’s figure will not be as bad. For the time being the Fed is leaving interest rates unchanged, tellingly using the term “transitory” to describe the unexpected decline in GDP which may signal its belief that better numbers are soon forthcoming.
At times like this a good place to look for a read on investor psychology is the S&P 500 Volatility Index, or VIX, which measures a basket of put and call index options to determine to what extent investors are willing to bet on higher than usual stock market volatility. The math is too complicated to explain here, but suffice to say that its recent spike above 14 implies an expected move in the stock market – one way or the other – of approximately 4% over the next month.
As recently as January the VIX jumped up to 22, and has steadily declined over the past three months as corporate earnings have consistently surprised to the upside. But even at an elevated reading of 14 it is still on the low side; over the past five years its average daily closing level has been a little over 18, occasionally shooting above 40 and never dropping below 10. If the VIX is to be believed, then the wall of worry being built over last month’s GDP figure is likely to crumble from the next gust of good news.
The biggest single contributor to corporate losses during the first quarter of this year was the strong dollar, which cheapened the value of overseas sales by as much as 10% or more for many U.S. multinational businesses. And to borrow a term from the Fed, those write-downs are transitory as the already weakening dollar should reverse that trend when the next set of quarterly reports start hitting the street this summer.
A quick stock market correction in the 5-10% range would not be surprising given how much it has appreciated during the past five years, but anything more than that is not warranted by the economic data. The present forward (12-month) P/E Ratio for the S&P 500 of 18 is a bit high by historical standards, which when converted to its inverse, or Earnings Yield, of 5.26% means it is less than 8% above its long term average of 4.86%.
All of that math may count for nothing if investors begin stampeding towards the exits, but if they do then a fresh buying opportunity may soon emerge. While the threat of global deflation should not be taken lightly, at the moment there is not enough proof of its eventuality to warrant panic selling.