Consumer Cyclical Stocks Suggest Too Much Economic Pessimism!??
by James Paulsen, Chief Investment Strategist, Wells Capital Management (Wells Fargo)
Financial markets often give conflicting signals regarding the economic outlook. Today is no exception. In the last couple months, some market signals suggest upcoming economic challenges including the collapse of stock markets about the globe, a ballooning of junk bond yield spreads, and a massive decline in the 10-year Treasury bond yield to record lows. Alternatively, other market signals suggest economic conditions are not nearly as dire. U.S. 10-year Treasury swap spreads remain very low (implying the likelihood of a European crisis contagion flying the pond is remote), one of the most economically sensitive stock sectors, technology, continues to lead the stock market and the price of gold has recently declined seemingly losing its safe-haven bid and suggesting the worst may be over.
Consumer Cyclical Stocks Lead the Way!
One of the most interesting financial market messages, however, is coming from the U.S. consumer— specifically from consumer cyclical stocks. Chart 1 shows the relative price performance of the S&P 500 Consumer Discretionary Stock Price Index. This index has not only been leading the overall stock market throughout this recovery (even during the recent economic soft patch) but has recently risen to an “all-time” record relative price high!
The U.S. consumer has long been the epicenter of economic worry in this recovery. Supposedly the consumer is struggling under a mountainous debt burden, lacks sufficient savings, and faces a job market which is widely perceived as comatose. If this accurately describes reality, why are the most cyclical consumer stocks—those driven by “discretionary” consumer spending—leading the overall stock market? At a minimum, Chart 1 implies that recent widespread expectations for an imminent U.S. recession are probably overstated. The shaded bars in this chart illustrate recessions. Every recession in the last 50 years (admittedly, not by much prior to the 1982 recession) has been preceded by a significant decline in the relative stock price performance of consumer cyclical stocks. By recently achieving a new all-time record high, consumer discretionary stocks suggest a U.S. recession is likely still some ways off. Better Job Creation Coming?
As illustrated by Chart 2, the relative stock price performance of consumer cyclicals has not only provided an early recession warning, but has also proved a good leading indicator of future job growth. This chart overlays the annual growth in nonfarm payroll employment (solid line) with the detrended relative Consumer Discretionary Stock Price Index. Since at least the early-1960s, periods of consumer cyclical stock outperformance have typically been followed (with a variable lag) by accelerating private job growth. Annual private job growth has been hovering about one percent in recent months. However, the recent upside breakout in the relative price performance of consumer cyclical stocks suggest job growth may accelerate in 2012.
Are Consumer Stocks Reflecting a “Better than Perceived” Job Market?
It is hard to reconcile new all-time record highs in the relative stock price performance of consumer discretionary stocks with the widely held perception that the U.S. job market has nearly stalled this year. Could this be because U.S. private job growth has not stalled this year but rather has actually “accelerated”? Moreover, could it be because private job creation so far in the contemporary economic recovery has been far better than it was in the 2001 recovery and nearly as good as it was in the early-1990s recovery? So far this year, as shown in Chart 3, the average monthly private payroll gain has been just shy of 150 thousand compared to an average monthly gain of slightly less than 100 thousand last year. That is, the pace of private job creation so far this year is nearly “50 percent faster” than it was last year! No wonder consumer cyclical stocks are doing so well.
Finally, despite an almost universal impression the contemporary private job market recovery is the weakest ever, Chart 4 shows it actually compares quite favorably with the last two recoveries during the last 25 years. Through the first 27 months of this recovery, private job gains have risen by 1.3 percent— far better than the net job loss which was evident at this point in the 2001 recovery and only slightly less than the gain which occurred at this point in the early-1990s recovery!
Summary???
Of the many financial market signals economist are monitoring for clues regarding the future of the economic recovery, we think the message provided by the relative price performance of consumer discretionary stocks may be the most interesting. The consensus view has been the economy, job creation, and consumer spending nearly flat lined during the first half of this year placing the U.S. economy on a path toward an imminent double-dip recession.
While some financial market signals do indeed suggest elevated recession risks, the performance of consumer discretionary stocks steadfastly portray the odds of an imminent recession as very remote. Rather, their performance suggests that underlying economic momentum (particularly in the household sector) may be far stronger than most perceive.
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