The Daily Reckoning UK

These Surprises Could Shatter Stock Markets

David Stevenson

by

Posted 19th April 2017

That was a surprise. Theresa May’s snap election call, I mean.

Don’t worry: I’m not going to bore you with my thoughts about it now. I leave political chit-chat to others. To repeat, though – it was a genuine surprise. And it helped to sink the previously-buoyant UK stock market by around 2.5%.

As someone who’s been forecasting a FTSE100 fall, I’m hardly shocked about that. OK, the (partial) catalyst was a sterling surge that’s seen as bad for corporate Britain as it makes UK exports more expensive. But there’s a key point here for the future.

High-flying equity markets don’t like unexpected uncertainties. A quick-fire general election has the capacity to serve these up in spades. When share price indices are standing at elevated levels, as they are at the moment, further falls may be sparked by even quite small adverse surprises. In particular if the latter are related to the economy rather than politics.

Today I’m going to take a closer look at the connection between economic upsets and the US stock market. And right now it’s painting a pretty scary picture.

The Citigroup Macro-economic Surprise Index tracks how well overall economic data is doing in comparison with consensus forecasts of market economists. Here’s a chart (for which thanks to Zero Hedge) of the US version of the index. As you can see, this has cratered in 2017’s second quarter, meaning that recent published data have turned out to be significantly worse than the experts had expected.

In other words, the Citi Macro-economic Surprise Index for the States has just plummeted to five-month lows in its biggest drop since 2010.

How does this plunge compare with the S&P 500 index, the world’s most widely-watched equity benchmark?

The chart below is self-explanatory. Sure, the correlation isn’t exact. Yet if history is any guide, we can expect the S&P to take a sharp tumble in the near future.

Source: Zero Hedge

If the S&P 500 index cracks, share prices in London – along with the rest of the world – are very likely to follow suit.

Now I’d like to show you three examples of recently-released poor economic data.

First, US industrial production (IP): American monthly manufacturing output fell by a disappointing 0.4% in March. In fact IP peaked way back in November 2014 and remains almost 2% below those record highs. And its 30-month rate of change (ROC) indicator – a statty-sounding measure but one that’s well worth monitoring – has dropped into negative territory again, notes Zero Hedge.

This has never happened before without the US economy being in recession. It begs the obvious question – is an American recession now starting to develop?

To help answer that: a second barometer of the country’s economic well-being, the performance of the US restaurant industry, is also giving bleak readings.

February’s Restaurant Industry Snapshot complied by TDn2K said that turnover and traffic “tumbled”, with same-store sales dropping 3.7% and traffic declining by 5%.

There were hopes of a rebound in March. Yet these have just been dashed as same-store sales worsened another 1.1% while traffic dropped by 3.4%. Though the timing of Easter has been a distorting factor, sales have now been negative in 11 out of the last 12 months. That’s the longest stretch since the great financial crisis.

Third – again self-explanatory – America’s used car market is looking very sick. You can draw your own conclusions from this chart (again thanks to Zero Hedge) from the US National Dealers and Automobile Association (NADA) price index. Despite hopes of a recovery, in fact it’s falling faster than before.

Once more, that’s hardly compatible with soaring US share prices. Sure, the stock market is driven by lots of moving parts and doesn’t always respond badly to each individual piece of unexpectedly poor economic news. But when the data are added up, it’s clear that the number of adverse surprises is growing fast.

While the S&P 500 has already slipped slightly from the peak, the decline in the index could still have a long way to go. This remains a time to be very wary about equity markets on both sides of the Atlantic.

At Strategic Intelligence we don’t claim to know where stock prices will be standing next week or even next month. But we do focus on highlighting the long-term risks to your portfolio. You can find out more about us here.

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