Leading indicators support market strength

As published in the Minneapolis Star Tribune 11/13/2021.

There is always an argument to be made that the stock market is overvalued. Here’s a sampling of the current menu for pessimists:

  • Fed tapering is imminent
  • Stubbornly high inflation
  • Earnings growth has peaked
  • Delta variant prolonging the pandemic
  • Supply chain disruptions

All of those are legitimate factors when considering economic outlooks, but don’t forget the following: In financial media, bad news and bearish outlooks make for better headlines. That’s especially the case when markets are trading at historic levels.

On Nov. 8, the S&P 500 closed higher for the eighth day in a row. It was the 65th record-high so far this year. Let’s be honest, you can only report “Stocks close at another all-time high” so many times before it’s met with a shoulder shrug and a channel change.

It’s a symptom of bull market-fatigue that it’s easier listing reasons to be negative than optimistic. We can help with that.

Leading economic indicators — the statistics that reveal clues about future economic health — still paint a positive picture. Unemployment claims, consumer spending, manufacturing, and construction/building permits are examples of leading indicators you are probably familiar with.

Each month, the U.S. Conference Board publishes a Leading Indicators Index made up of 10 indicators weighted to consider the relative impact of each. The idea is to take the temperature of an ever-changing economic landscape and gauge whether conditions are getting better or worse.

The most recent data suggest overall conditions continue to improve for American businesses. In the Conference Board’s own words, “The U.S. LEI rose again in September, though at a slower rate, suggesting the economy remains on a more moderate growth trajectory compared to the first half of the year.”

More than 18 months into this bull market, a slower “rate of improvement” in economic conditions is still significant. Think of a marathoner training for their 10th race, now shedding only seconds off their average time-per-mile. Both continue to get better.

Could inflation disrupt all of this? Unlikely. We expect inflation will stay elevated for a while, which is not unusual in the context of long-term market cycles. That doesn’t mean equities are destined for losses. Stock valuations historically are inversely correlated to inflation, but the “E” in the P/E (price-to-earnings) ratio can make up for that, and corporate earnings continue to outperform expectations.

The Consumer Price Index (CPI), by the way, is actually a lagging indicator of economic conditions, meaning the annual rate of inflation is not particularly helpful for predicting future returns.

What about buying into stock prices at all-time highs, you ask? It’s not nearly as problematic as you might think. In the last 65 years, the S&P 500 has risen 7.7% on average in the 12 months following an all-time high. Data compiled by J.P. Morgan shows that since 1988, buying the S&P 500 on days it closed at new highs actually produced better 1, 3, and 5-year returns than buying on an average day.

Momentum can be an incredibly powerful force in the market.

Risks, of course, are ever-present in investing, which is why stocks climb the proverbial Wall of Worry, but the leading economic indicators support the current strength in equities and more gains ahead. More volatility may very well come with it, but the 12-to-18 month outlook remains favorable.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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