It is often noted that the economy and stock market do not always rhyme. Certainly the past weeks have witnessed both rising U.S. economic data and tumbling financial markets. We believe this is the next chapter of a story that began in the aftermath of the financial crisis. A quick review of how the economy and market became disconnected will reveal our forecast for how they reconnect.
Over the past few years, the Federal Reserve’s efforts to rebuild economic stability also helped embolden confidence-wounded investors to take stock market “risks,” even in the face of often substandard economic data. Given these promises, the market didn’t need the economy’s help: policymakers had its back. Now, the U.S. economy is showing sustainable strength and the Fed is trying to reduce its role in future market movements. As a result, the equity market increasingly needs the economy to propel it higher. Yet, the chorus of economic naysayers, and China’s growth problems, have conspired to push equity markets’ lower — for the time being.
We believe U.S. economic growth is sustainable, and we’ll continue to cite a U.S. consumer that is increasingly healthy, confident and ready to take the reins of economic growth from the softening U.S. manufacturing sector. Witness the burgeoning U.S. housing recovery. Interestingly, the long-awaited additional spending “fuel” from the gas price decline may finally be arriving. Consumers initially doubted the gas price slide was permanent and forecast a quick return to high-priced gasoline. This likely discouraged consumers from spending: they thought the savings were temporary. But as in most areas of life, persistence triumphs: recent consumer sentiment data from the University of Michigan suggest that continued low prices may have finally convinced consumers that the change is permanent. Additional spending may be on the way.
The Multi-Asset Solutions Team believes that equity market volatility will continue until the Fed hikes interest rates, initiating the final step in the reconnection process. Only then, by withstanding rate hikes, will the U.S. economy be able to prove its mettle and quiet the naysayers. Our positive economic outlook suggests to us that the rising economy will eventually lead to a “rhyming and rising” U.S. equity market. While nearterm volatility is never enjoyable, our positive intermediate- to longer-term outlook leads us to continue recommending a slight overweight to risk assets.