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Latest Economic Data Enough to Keep the Stock Market Moving Higher?

Latest Economic Data Enough to Keep the Stock Market Moving Higher?

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Published by gloriasimmon
http://www.investmentcontrarians.com/recession/latest-economic-data-enough-to-keep-the-stock-market-moving-higher/1337/

One of the stock market’s most perplexing moves for both professional and retail investors is when the market, best represented by the S&P 500, moves in a direction that might be contrary to current conditions regarding economic growth.
http://www.investmentcontrarians.com/recession/latest-economic-data-enough-to-keep-the-stock-market-moving-higher/1337/

One of the stock market’s most perplexing moves for both professional and retail investors is when the market, best represented by the S&P 500, moves in a direction that might be contrary to current conditions regarding economic growth.

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Published by: gloriasimmon on Jan 31, 2013
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Latest Economic Data Enough to Keepthe Stock Market Moving Higher?
BySasha Cekerevacfor  Investment Contrarians| Jan 30, 2013 One of the stock market’s most perplexing moves for both professional and retailinvestors is when the market, best represented by the S&P 500,moves in a direction that might be contrary to current conditions regarding economic growth.This is one of the most difficult concepts to understand; that the S&P 500 does notrepresent current economic growth conditions, but what the market believes is highly probable for the future.We have recently witnessed a substantial move upward in the S&P 500, yet only recentlyhave we seen some positive signs that economic growth may be
 slightly
improving. Istress “slightly,” because no one really expects economic growth for 2013 to be massive.While jobs growth has been relatively weak, there have been some signs that suggesteconomic growth is resuming. However, with much of the data, there can be quite a lot of noise that can distort the underlying strength or weakness of economic growth.One example of a data set that does point to renewed economic growth, though thefundamentals may not be quite as strong, is the recent HSBC Flash China ManufacturingPurchasing Managers’ Index (PMI), compiled by Markit Economics. In January, theChina Manufacturing PMI came in at 51.9—a two-year high, up from 51.5 in December.The January China Manufacturing Output Index was 52.2—a 22-month high, up from51.9 in December. (Source: “HSBC Flash China Manufacturing PMI™: Operatingconditions improve at the quickest pace in two years,” Markit Economics web site,January 24, 2013.)
 
Initially, this seems to signal that economic growth in China is starting to resume, whichwould be bullish for the S&P 500. I also feel this information has greater legitimacy, as itis not conducted by the Chinese government, whose data can be questionable. However, astatement that worries me regarding just how strong the underlying economic growthreally is comes from this remark by Hongbin Qu, Chief Economist, China and Co-Headof Asian Economic Research at HSBC: “Despite the still tepid external demand, thedomestic-driven restocking process is likely to add steam to China’s ongoing recovery inthe coming months.” (Source: Ibid.)To me, this indicates that the optimism was due, in large part, to businesses rebuildingtheir inventory levels, not growth in end-user demand. This is similar to a retailer stocking up prior to the holidays, hoping for a strong season. It would be quite different if the index was rising due to strong demand from the end-user.This is the type of economic growth data that might initially propel the S&P 500 higher, as investors project out 12 to 16 months; however, if sales do not pick up globally, wecould be left with a glut of inventory in China.Another recent data set worth mentioning is the Markit Flash Eurozone PMI, which wasalso positive, coming in at 48.2 for January versus 47.2 in December. The Januaryreading was a 10-month high. All parts of the eurozone PMI index showed positive signs,including the services and manufacturing areas. While the PMI was below 50, signalingcontraction in the eurozone’s economy, the move upward to 10-month highs gave someindication that economic growth was just around the corner. (Source: “Markit FlashEurozone PMI™: Eurozone downturn eases as PMI hits ten-month high,” MarkitEconomics web site, January 24, 2013.)While I don’t doubt the legitimacy of these new data, I do worry that sentiment mighthave moved too far ahead of reality. Most humans are optimistic by nature. We all wantto believe that economic growth is just around the corner. Especially in Europe, therecent quiet in the credit markets has led many to believe that the worst is over. Nobody can predict the future, but what we can do is look at probabilities and marketsentiment. With the recent move upward in the S&P 500, while there are some signs thateconomic growth is destabilizing, we are not in a booming economy. Considering howhigh the S&P 500 has moved, it is quite possible that the market has priced in a great dealof good news already.
 
Chart courtesy of www.StockCharts.com
The S&P 500 is now near the upper end of its trading range. The relative strength index(RSI) is showing a slightly overbought condition, which does not necessarily mean thatthe market will have to go down; however, it is starting to become overpriced.Investors always want to get ahead of the curve. Many who have profited from thesubstantial increase in the S&P 500 will now need to see substantial economic growth to justify current valuations. Does this mean that the S&P 500 needs to fall immediately? Of course not; however, this does mean that economic growth numbers need to besubstantially stronger over the next couple of months or we will see investors begin totake profits, which will lead to a lower level in the S&P 500.I would never recommend calling a top or bottom in a market. I would, however,certainly urge caution for new funds being allocated into the S&P 500 at currentvaluations. The stock market is certainly pricing in an increase in economic growth. Andwhile we have seen some positive signs, we don’t know yet if this is sustainable.

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