Ian Mathias

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Irrational Exuberance Continues

The stock market is about to finish the best July since 1989. The S&P 500 is up over 8% this month, its best month since April and best July in 20 years. After yesterday’s 1% rally, the index is up to 987. Baring catastrophe today, the S&P will register its fifth consecutive monthly gain.

With data like this? C’mon:

The U.S. economy shrank at 1% annualized rate in the second quarter, the Commerce Department estimates today. Since that’s better than the 1.5% contraction the Street had predicted, we see headlines of “The Pain Is Easing,” and “Recession Easing” left and right. True, the latest GDP number is better than that of previous quarters, but here are some of the stats that really got our attention:

  • The U.S. economy has now contracted four quarters in a row, the worst streak since the Great Depression
  • GDP has contracted 3.9% in the last year, the worst fall since at least 1947, when the Commerce Department started keeping track
  • First quarter GDP was revised down heavily, from a 5.5% to 6.4% — the biggest quarterly GDP drop in almost 30 years
  • The Commerce Department revised 2008 down too, from a 0.4% annual contraction to a 1% decline
  • Consumer spending, 70% of U.S. GDP, contracted 1.2%. The retrenchment was largely replaced by government spending, up 10.9%
  • Employment compensation rose by just 1.8% over the last 12 months, the slowest rate on books that go back to 1982.

But as you’d expect, the market has clung to the expectations-beating, lower-than-usual headline GDP. Thus stocks are currently holding onto yesterday’s gains and hovering around break-even.

“The modest bounce in consumer confidence last spring is fading already,” writes Eric Fry, “and that’s not a good sign for the stock market. As the chart below illustrates, consumer sentiment trends tend to lead stock market trends.

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“Throughout 2007, consumer confidence flat-lined while share prices rallied. This divergence between sentiment and share prices became particularly extreme in late 2007, as share prices soared to new highs while consumer confidence plummeted. Just a few months later, share prices were plummeting also.

“The lesson is clear: If consumers lack confidence, so should investors. During the last two months, share prices have diverged once again from consumer confidence readings. This is not a promising sign.

“And yet, despite this warning sign, lots of hopeful investors have persuaded themselves that the mirage of economic rejuvenation is the real thing. We’re not drinking that sand.”

The Daily Reckoning