The connection between economic growth and the stock market, best represented by the S&P 500, is a complicated affair. Many investors mistakenly believe that both need to be moving in the exact same direction at the exact same time.
But nothing could be further from the truth. For evidence, take a look at the economic growth rate over the last few years. While it’s quite clear that economic growth has been very anemic, the S&P 500 has in fact had a huge positive return.
There are actually many reasons that could push the S&P 500 up. Economic growth is obviously one of them, in addition to the profitability of the individual companies, many of which obtain revenue from international sources and don’t depend entirely on economic growth in the U.S., as well as the increase in monetary stimulus by the Federal Reserve.
I have been of the opinion that the Federal Reserve has primarily fueled much of the move up over the past few months.
The news that the Federal Reserve might begin to reduce its asset purchase program has led to a significant decrease in the S&P 500 as investors whose primary catalyst was monetary liquidity ran for the exits.
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However, easing the stimulus can only occur if economic growth accelerates—the Federal Reserve was clear about that fact. The problem is that the data regarding economic growth remain mixed.
This week was a good example of the various mixed messages. On Tuesday, several data points indicated the potential for strong economic growth, including durable goods orders (both core and headline) far above estimates, consumer confidence moving dramatically higher, and the S&P/Case-Shiller home index showing a record year-over-year increase in home prices.
However, on Wednesday, the Bureau of Economic Analysis released final gross domestic product (GDP) for the first quarter at 1.8%, well below earlier estimates of 2.4%. (Source: Bureau of Economic Analysis, June 26, 2013.)
In this case, the final GDP data point indicates that economic growth was below estimates, leading some to believe that the Federal Reserve might keep its foot on the accelerator, which is bullish for stocks. However, the data are quite old, and the more recent data are showing potential for economic growth.
These mixed messages are leaving investors understandably confused.
Chart courtesy of www.StockCharts.com
As they say, talk is cheap and actions speak volumes. The charts show us what people are actually doing. The S&P 500, following the recent sell-off after the Federal Reserve meeting, has started to move back up toward its trend line, as you can see in the chart above.
While some investors might believe that the Federal Reserve will continue pumping liquidity, helping propel stocks back upward, I disagree with that assessment because of the current position of the S&P 500. For me to become bullish once again on the S&P 500, as I’ve been for much of the time since last fall, it would need to move back above the upward-sloping trend line.
However, I think it is far more likely that the S&P 500 will attempt to break above this resistance but fail. Of course, if the S&P 500 were to sustain a breakout from resistance, it would naturally lead me to consider a retesting of the highs for the year as likely.
With earnings season coming upon us shortly, unless companies report extremely positive surprises, I think there will be an extensive amount of resistance at the 1,650 level in the S&P 500.