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Economic Growth Weakens While Inflation Increases

Coinbase CEO
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EDITOR'S NOTE: Despite disappointing earnings from major market-movers like Starbucks, Apple, and Amazon, the market is (shockingly) still on a bullish pace, even with economic growth strengthening and inflation increasing. While this is an impressive feat from the market, Real Investment Advice reports that “The more significant concern, however, remains the underlying technical condition of the market. While the rally has been impressive, rising almost 6% from the recent lows, the market is now back to more extreme overbought levels, trading 2-standard deviations above the 50-DMA, and breadth remains troubling.” With the Fed possibly set to start tapering bond purchases as early as the first week in November, this house of cards could come falling down very soon. 

Market Back To Extreme Overbought

With earnings season in full swing, stocks continued to push higher this week. Even disappointing earnings from Starbucks, Apple, and Amazon couldn’t keep the bulls down much. So far, the earnings season has pretty much aligned with expectations. As noted by FactSet:

Overall, 56% of the companies in the S&P 500 have reported actual results for Q3 2021 to date. Of these companies, 82% have reported actual EPS above estimates, which is above the five-year average of 76%. If 82% is the final percentage for the quarter, it will mark with the fourth highest percentage of S&P 500 companies reporting a positive earnings surprise since FactSet began tracking this metric in 2008. In aggregate, companies are reporting earnings that are 10.3% above estimates, which is also above the five-year average of 8.4%.”

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

Earnings have indeed been very impressive, but as we will discuss, this quarter will likely mark the peak of growth for a while.

The more significant concern, however, remains the underlying technical condition of the market. While the rally has been impressive, rising almost 6% from the recent lows, the market is now back to more extreme overbought levels, trading 2-standard deviations above the 50-dma, and breadth remains troubling.

Chart updated through Friday.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

As noted last week, our “money flow buy signal” is near a peak and is close to triggering a “sell signal.” With the MACD still positive, the signal suggests more consolidation than correction. However, a confirming MACD often aligns with short-term corrections at a minimum. Also, as shown, this entire rally from the recent lows has been on very weak volume, which suggests a lack of commitment.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

At the moment, the bulls control the market, and downside risk is somewhat limited. However, that positioning is getting very aggressive.

Aggressive Positioning

As noted, the current spat of economic weakness, combined with rising inflationary pressures, doesn’t bode well historically for asset markets. However, the recent 5% correction did little to reverse more aggressive positioning. As shown below, the NAAIM Index (Fund manager positioning) has surged back levels that have previously aligned with short-term corrections or worse.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

Such is not surprising given the massive inflows of capital into the market this year alone which have now exceeded $1 trillion. (Chart courtesy of Zerohedge)


Market Melts Up Economic, Market “Melts Up” As Economic Growth WeakensPhoto: Real Investment Advice

Furthermore, with the window for corporate share buybacks opening in November, the primary buyer of equities will return to the market. Share buybacks are already at a record and could add as much as $90 billion to the total by year-end.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

While capital flows certainly support the bullish narrative in the short-term, such can get easily reversed with a change in sentiment. As noted, with economic growth weakening and inflation increasing, the risk of a reversal is increasing. Moreover, the chart shows that previous spikes in inflation have not been kind to equity returns.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

Of course, inflation also hurts economic growth which impacts profit margins.

Economic Growth Weakens

In March of this year, I penned an article entitled “Sugar Rush,”wherein we discussed the economy would run “hot” and then “crash.” At the time, I received a lot of “pushback” on my “dire predictions” of economic growth later in the year. Furthermore, I followed that analysis asking if Q2 was the “Peak Of Economic Growth?” To wit:

Was the second quarter the peak of economic growth and earnings? If estimates are correct and the year-over-year ‘base effect’ fades, such suggests risk to current earnings estimates. The chart from a “Grossly Defective Product,” utilizes the Atlanta Fed’s current estimates for Q2-2021 GDP. The full-year estimates are from JP Morgan. Notably, the economy quickly slows to 2% heading into 2022.”

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

At that time, we estimated less than a 4% growth rate for the economy, with the Atlanta Fed well above 6%. On Thursday, the initial release of Q3 GDP came in well below even our lowered expectations of just 2%.

Real gross domestic product (GDP) increased at an annual rate of 2.0 percent in the third quarter of 2021 (table 1), according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 6.7 percent.” – BEA

Notably, the “advance estimate” is derived from a sampling of economists’ estimates. As actual data gets factored into the GDP calculation during the next two months, the growth estimates will get revised. As discussed in “The Bullish/Bearish Case,” the weakness in the economic data suggests those GDP revisions will be lower.

Market Melts Up Economic, Market “Melts Up” As Economic Growth Weakens

Photo: Real Investment Advice

The implications of weak economic growth are broad. Consumer sentiment will remain weak as inflationary pressures undermine consumption. Furthermore, the negative impact on earnings seems to elude investors currently.

Originally posted on Real Investment Advice.

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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