The equity indices take a dive. Is this in spite of — or because of — the fundamentals?
Figure 1 depicts the evolution of the S&P 500 over the past five days.
Figure 1: S&P 500 index. Source: finance.yahoo.com.
Here is the key series that is cited as one of the proximate causes of the sell-off (along with China and subprime mortgages)[added 4:30 PM]. Also depicted is the total durable goods order series.
Figure 2: Log new durable goods orders, in millions of dollars, SA, and three month moving average (red). Source: St. Louis Fed FREDII.
Figure 3: Log new nondefense capital goods orders ex. aircraft in millions of dollars, SA, and three month moving average (red). Source: St. Louis Fed FREDII.
Both series exhibit a pronounced downward movement, even in the three month moving average. While this has happened several times before in the period since the end of the last recession, it has not happened in the capital goods series in the last two and a half years.
What about capacity utilization and industrial production? As Jim mentioned in a recent post, both have been exhibiting worrisome trends. Capacity utilization in manufacturing is substantially below mid 2006 levels, while industrial production (an upward trending variable) has been trending sideways since the middle of last year.
Figure 4: Capacity utilization in manufacturing (blue) and log industrial production (red), both seasonally adjusted. Source: St. Louis Fed FREDII.
What about the consumer? 70% of GDP is accounted for by consumption, so the consumer is key. The real retail and food sales and especially the retail ex. food sales series growth rates are essentially zero over the last year, as shown in Figure 5.
Figure 5: Log retail and food sales deflated by CPI-All (blue) and log retail sales deflated by CPI-All (green), both seasonally adjusted; and three month moving averages (respectively, red and black). Source: St. Louis Fed FREDII.
These trends in spending are interesting given the fact that population and real GDP are growing over time. (I’ll leave the discussion of the housing market to others, such as Calculated Risk).
Finally, not a “fundamental” but another forward looking indicator: the yield curve. As has been discussed often, here and elsewhere, there is econometric work supporting the proposition that the term spread no longer predicts recessions — a binary variable — well (although it still might predict economic activity). The ten year constant maturity minus 3 month spread is depicted in Figure 6. The red square is the observation for today.
Figure 6: Ten year constant maturity Treasury yield minus three month Treasury yield. Source: St. Louis Fed FREDII.
Given these indicators, maybe one should not be surprised by the equity market movements. Even if there’s no recession on the horizon, a more marked slowdown should force downward the expected stream of earnings (and hence dividends) into the future.