· This week we look at some interesting, under-the-radar breakouts in the economy and markets.
· The breakout in economic surprises is a positive sign for the stock market and cyclical sectors.
· The breakout in valuations suggests only potential moderate gains for stocks in the near term.
· The breakout in emerging markets suggests strong recent performance for that group may continue.
The S&P 500, Dow Jones Industrials, and other major indexes have recently broken out to new highs. But this commentary is not about the breakouts in those indexes (check out lplresearch.com for more on those). Nor is this commentary about the classic video game called Breakout that debuted in the mid-1970s, which some of us more seasoned investment professionals recall. And it’s definitely not about the 2008 Miley Cyrus album by that name (even though the authors of this report have six daughters between the two of them). In this week’s commentary, we look at some interesting, under-the-radar breakouts in the economy and markets.
Breakout #1: Economic Surprises
Many wonder how the stock market can do so well when S&P 500 earnings have not produced any gains since the second quarter of 2015, and even then earnings grew by a meager 1.3%. Valuations have risen, which has been helpful (more on that below). Central banks have also helped, which could explain why the VIX measure of stock market volatility is sitting near post-financial crisis lows and about 7 points (or 35%) below its 25-year average. But another reason that few would cite is that economic data have been increasingly beating expectations—our first featured breakout.
The Citigroup Economic Surprise Index, or CESI, tracks how economic data are faring relative to expectations. The index rises when economic data exceed economists’ consensus estimates and falls when data come in below estimates. After an 18-month stay in negative territory, the July 8, 2016 reading put the index above zero [Figure 1].
Economic growth has not picked up during this time period but the data have been better than expected, supporting stocks during their recent ascent—including the month since the Brexit vote in the U.K.—highlighted by the June Institute for Supply Management (ISM) Purchasing Managers’ Index (53.2 versus 51.4 expected) and the June Employment Situation report (287,000 net new jobs versus 175,000 expected).