The past couple weeks have seen a surge in investor optimism and rising fund flows into equity funds even as oil prices climb back towards $100, and investors marinate on the fact that taxes will take another 5 percentage points out of capital gains and income.
The change in sentiment is pretty remarkable, and it smacks of a Texas rodeo bar where patrons plug rolls of quarters into the mechanical bull during happy hour, having just all kinds of fun and whooping it up.
I get the relief aspect of the rally. The market wasn’t dealt a fiscal blow at the end of December, a lot of cash that missed last year’s rally was anxious to get long equities, and Europe, China and Japan promised to print as much stimulus as necessary to compete with the Federal Reserve. To say the market has been anything but bubbly wouldn’t do it justice.
On the macroeconomic front, though, the data has been mildly positive — and the market might be getting ahead of future expectations. Let’s look at a few points of interest to shed a little light on the economy.
Indicators Positive, But Don’t Suggest a Big Spike
Last Friday, the Conference Board’s Index of Leading Indicators showed a 0.5% increase in December after being unchanged in November. That was exactly what the consensus expected. The poor reading in November was the result of Hurricane Sandy causing a spike in the initial claims level. As the jobless numbers returned to their long-term trend, leading indicators showed a solid rebound. Discounting the fluctuations in the initial claims level, the leading indicators would have increased 0.4% in November and 0.1% in December, registering a pullback in economic activity.
Industrial production for the first half of January was up 0.3%, an OK report. Initial weekly jobless claims of 330,000 were well below the 365,000 forecast, so bullish. Housing starts for December of 954,000 also were well above the 880,000 estimate.
However, the Philly Fed report for January came in at -5.8 versus a forecast of 1.0, and consumer sentiment for January came in at 71.6 versus consensus estimates of 76.0. Durable goods for December posted a 4.6% gain against forecasts of 2.5%, and pending home sales fell 4.3% versus expectations that the data would stay flat.
Sounds like a push to me.
So, being about halfway through earnings season — where 60% of companies are reporting earnings that are meeting or exceeding estimates — coupled with this collection of recent economic data points and record-high investor sentiment, one has to wonder where the next big catalyst is to drive the market higher.
It appears as if everyone has arrived to the party, with Main Street investors finally getting in at the very top of a rally.
Fund Flows From the Fed
The yield on the 30-year Treasury has been on the rise as of mid-November and spiked the first week of December when the Fed reported it would cease long-dated maturities sometime in 2013. Currently, the yield on the long bond is around 3.2%, up from the 2.7% level during November (a marked increase that is bullish for mortgage and hybrid REIT holdings).
Click to Enlarge The Fed finances most debt with very short-term maturities (1-3 years), so it is more focused on keeping short-term rates low, hoping the economy will pick up enough speed to boost tax revenue from both business and personal streams while keeping a close eye on inflation.
From what I can ascertain, the net effect on the recent pop in the long end of the yield curve and the spike in oil prices is that we can expect a marginal slowing of consumer activity in the weeks ahead.
On the other hand, if prospective homebuyers suspect that the window for buying a house at historically attractive terms is about to close, then we could see a big rush in the spring to secure cheap financing. But that piece of logic failed to show up in Monday’s negative pending home sales report.
The impact of higher taxes won’t have an effect for several months, but might provide some headwinds later in 2012. That said, the 20% top tax rate for qualified dividends and long-term capital gains was a clear win for stock investors all around and is partially responsible for the mad rush into stocks during the past three weeks.
While the economic and sentiment data doesn’t support a bigger move ahead, the numbers suggest that if and when a correction does occur, it will be mild, with a long line of buyers looking to buy the dip.
Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing.