Surprise us – please
One way to measure whether or not a peak in equity markets is being reached is to look at economic surprises.
Better-than-expected economic data, especially in jobless claims, helped fuel a year-end rally in the United States.
But there are signs that the rate of such good tidings is slowing down, and that could well herald lower equity returns, according to Brockhouse Cooper’s global macro strategist Pierre Lapointe.
He points to the U.S. Citigroup Economic Surprise Index, which tracks the rate at which data are beating or missing economists’ expectations over a three-month period.
Last summer, disappointing economic releases contributed to an equity decline, Mr. Lapointe writes in a strategy note.
Since early September, the data have again been surprising on the upside, “which explains in part why U.S. equities have rebounded 17 per cent since their most recent trough on Oct. 3.”
After slumping to a two-year low of minus 117.2 in June, the index rebounded as high as 85.7 in December. “History tells us that when the Surprise index is above 75, one should not expect economic data to boost equities further,” says Mr. Lapointe.
In the equity race, hares disappoint
It stands to reason that a country posting robust economic growth will have rising stock prices, right?
U.S. investment firm Gerstein Fisher analyzed the relationship between GDP growth and stock price performance in eight major developed and developing countries between Jan. 1, 1993 and Dec. 31, 2010. The results, according to president and chief investment officer Gregg Fisher, “were startling.”
“We found that the correlation between annual stock returns and economic growth is very tenuous – typically quite low and often even negative, as in the cases of China and South Korea,” he wrote in a note.
China’s dynamo economy, for example, expanded by 15.75 on an compounded annualized basis, but its annualized stock returns declined by 2.25 per cent over the 18-year period examined.
Brazilian stocks posted a 16.11 per cent stock market return rate but a growth rate of 9.76 per cent. And the U.S.’ relatively modest growth rate of 4.79 per cent was outpaced by a stock return of 8.14 per cent.
Mr. Fisher says there are many possible explanations, including the notion that expected economic growth is built into current prices, reducing future realized returns.
Another possible factor is the discrepancy that sometimes exits between a domestic stock market and the larger economy. The U.S. is home to many multinationals that increasingly sell abroad; they don’t add to U.S. GDP but do increase profits for shareholders.
The housing obsession
In what must be a concern for policy-markers, the last two quarters have seen a resurgence in the growth of housing investment, notes David Madani of Capital Economics.
Strong construction activity, combined with resale transactions and spending on renovations, boosted fourth-quarter residential investment by about 8.5 per cent on an annualized basis, he estimates in a report. That follows an even stronger 11-per-cent increase in the previous quarter.
Housing investment most likely outpaced overall GDP growth, with investment as a share of GDP probably climbing back toward a record high, he writes.
The problem is that the continued trend of strong housing investment and consumption does not reflect an equally strong improvement in economic fundamentals, he says, and the resurgence in housing investment is unlikely to be sustained much longer.
Income gains remain moderate, while growth in mortgage credit has stayed fairly solid, he points out. External factors, such as the worsening global outlook, don’t help boost confidence.
“As has been the case for over a year, Canada’s housing boom exhibits the typical signs of an asset price boom-bust cycle, which, when it turns, will have substantial negative implications for the broader economy,” he says.