Stocks are feeling wildly optimistic this morning. The ISM reported its manufacturing gauge fell to 55.5 in July from 56.2 in June, but that came in 1.5 better than the 54 level that economists had expected. The trend is clearly for weaker levels ahead as explained by TD securities this morning:
“New orders, which drives activity in related and downstream manufacturing efforts was weaker than expected falling to 53.5, the lowest level since mid-2009. Production was also down falling for the third straight month and while a reading of 57.0 is still pretty good, more downside is expected. The area of strength that cushioned the decline in July may have been unintentional. Inventories produced a tidy gain rising from a depressed level of 45 to just over 50, but like the Q2 GDP report, the jump in inventories is likely not intentional given the paucity of real final sales. As the ratio of new orders to inventories gets compressed, it suggests that production will continue to weaken with a lag, as will most other components. This is reinforced by orders backlog which also is moving lower, falling to 54.5 from 57.0. With orders being worked off and new orders becoming sluggish, inventories will be pared down and real demand will edge lower. We expect this to be reflected in Q3 GDP which should come in close to 1.6%.”
It is important to note that the ECRI leading indicator index which most recently reported a -10.9% weekly growth rate typically leads the ISM PMI by 13 weeks and 13 weeks ago the ECRI WLI was still a positive 12.7. This trend suggests that we could see the ISM PMI data fall officially into contraction mode this fall. This would be bad news for a stock market that is presently pricing in robust earnings growth.
For a series of very illuminating charts on the quality of this economic “recovery”, see Bill Hester's article today Subpar recovery gets premium market valuation at Hussman Funds:
“For investors, what's important is the extent to which expected growth in the economy and earnings is priced, or possibly overpriced, into the market. The current subpar recovery should probably warrant a below-average level of valuation compared with prior recoveries. Unfortunately, the opposite is true. To put the current level of valuation into perspective, the table below shows Robert Shiller's Cyclically Adjusted P/E Ratio (CAPE), which normalizes earnings by averaging the prior decade's results. The table shows that there have only been two other periods where the economy was recovering from a recession and the level of valuation was higher. One was in November 2002, a year following the end of the 2001 recession. The S&P 500 has achieved a total return of just 4.2% annually in the 8 years since then. The other instance was in February 1962, a year after the 1961 recession ended, when the CAPE was at 21.45 (the S&P 500 quickly lost a quarter of its value over the next few months). The average CAPE level for the periods shown is 16, versus the current level over 20”.
Seriously, these pictures cut through the spin of a thousand bullish commentators…well worth a look…