Boom Boom Pow: Have Stocks Already Priced in Economic Boom?

Key Points

  • Economic and earnings data are in boom territory, with more momentum likely near-term.

  • But the stock market tends to sniff out inflection points in economic data; so keep a close eye on growth rates, and the possibility of a peak in this year’s second quarter.

  • Low-quality momentum-based trading has given way to more fundamentals-driven leadership as stocks discount a move from early cycle to mid-to-late-cycle economic conditions.

With green all around us again now that winter is over (I know, in Naples FL where I live it’s always green); vaccines and herd immunity continuing to bring COVID cases down; and the economic reopening kicking into higher gear; the data is starting to shine. Across economic metrics—from gross domestic product (GDP) to retail sales to job growth—boom conditions are evident. So why have U.S. stocks had a fairly muted response (today’s strength notwithstanding); with range-bound trading (and two pullbacks) since mid-April?

Could market “disconnect” again from economy?

For the first six months of the stock market’s recovery off the March 23, 2020 low I was peppered with questions about the perceived disconnect between the stock market and the economy. This was particularly elevated by early-September 2020—at which point the S&P 500 and NASDAQ were trading at new all-time highs, while the economy was still in dire straits. My response at the time was to point out that if you peeled back the market’s onion just one layer, you would have seen that market leadership was incredibly narrow.

Year-to-date last year, through September 2, 2020, the “big 5” largest stocks in the S&P 500 (Apple, Microsoft, Amazon, Google and Facebook) were up 65%; while the remaining 495 stocks in the index were up only 3%. At that same time, nearly 40% of the S&P 500’s stocks were still in bear markets (down at least 20% from their 52-week highs). Frankly, that was reflective of an economy with a very small subset of winners, and a huge subset of losers. Fast forward to today, and I’m getting the question again; but with a mirror image characteristic, given economic and earnings data have been booming, and the stock market seemingly lagging a bit.

Leading edge

The key to understanding the relationship between economic data and the stock market is understanding the relationship among leading, coincident and lagging indicators. As most investors know, the stock market is a leading indicator; and as such, tends to trend with other leading indicators like unemployment claims, the yield curve, the average workweek, among others. Some of the more popular economic indicators—like payroll growth and retail sales—are coincident indicators, while the unemployment rate is one of the most lagging of economic indicators. Even GDP is lagging in nature given that the first read for each quarter comes a full month after the quarter ends—and with two subsequent revisions coming even later.