A lot of concerns are hanging over the U.S. economy right now after a disappointing start to the year, but optimists are pushing them aside with one bold argument: The second quarter is going to be so much better.
With the quarter's activity now taking shape, are these upbeat views realistic?
There is a lot at stake here. The S&P 500 has risen more than 180 per cent over the past five years without sustaining a correction of 10 per cent in nearly three years.
The gains have largely been built on a promising recovery, highlighted by impressive gains in payrolls, a falling unemployment rate, strong profit growth and a healthier housing market. If the recovery falters, the stock market is going to look extended.
Some signs are pointing toward trouble. In particular, U.S. gross domestic product contracted by 1 per cent in the first quarter – a huge disappointment that was downplayed by many observers as old news that had no bearing on the improved outlook for the rest of the year.
A consensus of economists expects the economy to expand by 3.5 per cent in the second quarter, at an annualized pace, making the first quarter look like a weather-related blip.
Observers are expecting big things from corporate earnings as well. According to Goldman Sachs, earnings for companies in the S&P 500 should grow by 8 per cent this year and next – and that's conservative compared to the forecasts from analysts, who see earnings growing 9 per cent this year and 12 per cent in 2015.
But the market isn't playing along with this sunny view just yet. The yield on the 10-year U.S. Treasury bond has fallen to about 2.5 per cent, down from 3 per cent at the start of the year. For sure, there are any number of explanations for the decline – from asset rebalancing, to falling European bond yields, to geopolitical uncertainty. But bond investors could be taking a more pessimistic stand on the economic recovery.
Also, the stock market is hardly in a euphoric phase. The S&P 500 has risen just 4 per cent so far this year – a slight gain that reflects a cautious mood on the part of investors.
The caution could be coming from the near-tripling of the S&P 500 since early 2009 and the fact that many strategists are arguing that stocks are, at best, fairly valued. But you can't rule out another potential reason: No one is quite buying the optimism.
David Berman