KFS Weekly Commentary
Message From the Markets
Stocks posted a strong first quarter. While shy of last year’s 12% first quarter gain, the S&P 500 Index’s 10% gain seen this year reflects very strong performance. Consistent with the powerful gains for stocks, bond yields and oil prices also rose in the quarter.
We devote careful study to the economic data to help us assess the outlook for the markets. What about the other way around? Given the average-at-best economic readings during the first quarter, the performance of the stock, bond, and commodity markets begs the question: what are the markets saying about where the economy is headed?
Does the performance of stocks, bonds, and commodities in the first quarter forecast that booming economic growth lies just ahead? Or might these market gains risk making April fools of those expecting a sharp economic acceleration?
Message From Stocks
Historically, the stock market has been a very good leading indicator of future job growth with a lead of about six months. Since most of last year’s gain came in the first quarter, after the strong first quarter of this year, the S&P 500 Index is up about 11% from a year ago. This does not suggest booming job growth in the coming months. In fact, the 11% gain suggests only about a 1 – 2% year-over-year growth rate for jobs or a pace of about 180,000 per month. This would mark a modest slowdown – rather than a sharp re-acceleration of job growth.
Message From Bonds
Traditionally, in the bond market a rise in long-term yields relative to short-term yields is indicative of a stronger outlook for economic growth. The bigger the difference in these yields, in technical terms known as the slope of the yield curve, the stronger the expected pace of growth for the economy. The difference in yields helps to predict gross domestic product (GDP) over the coming two years.
While short-term yields did not change in the first quarter, remaining pinned down by the Federal Reserve (Fed) at just under 0.1%, the yield on the longer term 10-year Treasury note rose from an average of 1.69% in the fourth quarter of last year to 1.92% in the first quarter of this year. While on the surface an increase in the slope of the yield curve may suggest a better growth outlook, the modest uptick in yield predicts merely a continuation of the roughly 2% GDP growth seen, on average, over the past couple of years.
Message From Commodities
After spending much of the fourth quarter of 2012 below $90, oil prices surged to near $100 in the first quarter, ending at $97. Since oil prices and economic activity tend to move in the same direction, is this $10 surge in oil prices a sign that demand is rising with increasing economic activity? Unfortunately, the answer is no. We can see in Figure 3 that this level of oil prices is consistent with the current modest pace of manufacturing activity represented by the widely-watched Purchasing Managers’ Index from the Institute for Supply Management in the low 50s.
Despite the strong performance in the first quarter, it appears that the message from the markets on the economy is that modest growth is likely to continue rather than accelerate. Just like last year, the strong first quarter led to more of the same in the economy, averaging 2% GDP growth and modest job gains.