They say hope springs eternal on Wall Street. And certainly, the army of buy-and-hold evangelists and perma-bull analysts — witness the call from Morgan Stanley Monday morning that the stock price on Tesla Motors (TSLA) is set to nearly double — reinforces that perception. But sometimes, reality fails the cheerleaders. The business cycle disappoints. Forecasts become overzealous.
That could be happening now.
Despite surface-level indications that everything is fine — with stocks range-bound, job growth continuing and the Federal Reserve still talking up rate hikes this year — many economic data points have begun to soften.
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Monday’s Empire State manufacturing activity survey badly missed expectations and plunged deeply into negative territory, indicating the worst contraction in output since the recession. New orders, backlogs and shipments all dropped outright. Seemingly at odds with last week's strong industrial production report, it makes sense when one filters out abnormal strength in U.S. auto sales.
The drags are export activity (weakness throughout Asia and Europe), overstuffed inventories and energy (as low crude prices limit capital expenditures in the oil and gas industry). J.P. Morgan economist Daniel Silver believes activity will remain constrained going forward. Capital Economics labeled the drop a "massive collapse" suggesting the factory sector "is in a lot more trouble than previously thought."
Retail sales, shown in the chart above, have been weak as well. The annual change in spending has dropped to levels associated with the start of the last two recessions. If falling gasoline prices were truly the boon to consumers that the optimists expected, spending would've been reallocated to other categories; instead, the money is being pocketed.
If factories aren't producing and consumers aren't buying, than the predictable result is a slowdown in overall corporate sales. And that's exactly what's happening, according to data compiled by Ed Yardeni of Yardeni Research. S&P 500 revenues and business sales have both slumped to levels associated with the start of the last two recessions, pushing down deeper than the temporary 1998 slowdown associated with the Asian financial crisis and Russian bond default. Removing the drag from energy — looking at non-petroleum business sales — still results in a similarly dour picture.
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I mention the 1998 scenario because of the slow-motion drop in the Dow Jones Industrial Average last week that resulted in a technical signal called a "Death Cross" — a plunge of the 50-day moving average below the 200-day moving average. It was the first such event since 2011.
That ended a streak of 906 days, the second longest run of market tranquility ever behind only a stretch that ended on Sept. 17, 1998. That was a volatile period as well but ended up being a great time to buy stocks: The Dow rose 12.7 percent over the next three months. While there are similarities between then and now — such as last week's currency devaluation by China — the data is much weaker this time.
Yardeni notes that "analysts may be overly optimistic" in their forecast of rising profit margins amid all this. This can be seen above, with analysts assuming that despite tepid top-line growth, companies can use accounting trickery, cost cutting and balance-sheet leverage to keep juicing earnings.
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If the analysts are wrong, it means stocks are even more overvalued than commonly assumed, with the cyclically adjusted price-to-earnings ratio on the S&P 500 already at heights only exceeded during the bubbles of 1929, 2000 and 2007. Still, hope springs eternal.
