Will the nascent US recovery finally push the S&P 500 & Dow to new highs?

The US Federal Reserve, headed by “Helicopter” Ben Bernanke, has been trying hard to put the US economy back on the rails to prosperity in recent years. After huge cuts in the country’s key interest rate and purchasing trillions of both government bonds and mortgage-backed securities growth has, finally, been picking up some momentum in recent months.

The US stock market has been in the vanguard of the global equity have recovery from the crisis low of March 2009 and some are now questioning whether the rebound is out of kilter and the market due a pull back. Certainly looking at the chart below of both the DAX and the S&P 500 there is an argument that it is time to take money off the table with a large disjoint opening up between the ECRI economic indicator and equity indices. Historically there has been quite a high correlation and the question is – has QE3 distorted this sufficiently that the correlation no longer holds or will the ECRI catch up with the S&P 500?

The consumer, housing sector and the job market have all been resilient in recent months and, it looks to us, as if real green shoots of economic recovery are growing in the US. When the FED launched its third round of monetary easing – QE3 with the open ended, unlimited nature was widely seen as the last shot of the ammunition by the FOMC – by making the bond purchases unlimited in nature, the controversial Ben Bernanke finally lived up to his nickname of “Helicopter Ben” – a reference to his postulations that if domestic demand weakened so much the FOMC could print dollars and helicopter drop them. True! As he has hit the “zero bound” of interest rates, aside from debt forgiveness in the private sector and absorption by the Government (in effect Zimbabwe-isation!), there is very little extra the US can do having hit the fiscal brick wall too.

The last few days have delivered continued good news on the economic front. The table below shows the most important data reported over the last two weeks. With the exception of the Empire State Manufacturing Index and the latest Initial Jobless Claims number, every other indicator came as a positive surprise, surpassing expectations.

Starting with the payrolls report, issued on October 5, although the headline number of payrolls creation was not stellar, at least was in line with expectations at 114,000. The number from the prior report was revised some way higher however. The unemployment rate was the big surprise at that time, decreasing from 8.1% to 7.8%. Market reaction was positive but still there was scepticism that figures were a result of a statistical issue rather than a real improvement. Nevertheless, the Michigan Consumer Sentiment reported last week showed a huge improvement and currently shows the best reading since 2007. The index is divided in two parts: current conditions and expectations. Both registered big improvements but the expectations part was up 6.0% from the prior report showing the consumer is confident about his future income prospects. In order for the consumer to be that confident, it means jobs are easier to come by and I suspect the next non-farm payrolls may show quite an improvement.

Retail Sales, Industrial Production & the Philly FED index all have shown big surprises this week. The leading indicators presented on Thursday confirmed the US economy’s accelerating the recovery. Regarding the housing market, which has been the most resilient of all sectors, news on Thursday was very positive as building permits and housing starts increased substantially from last month’s reading. It may be soon to say the US economy is well and truly back on the rails, but if economic indicators continue to point in this direction we rather suspect it is the ECRI index that will rise to meet the S&P and not vice versa. Investors are a little concerned with this earnings season, nerves being heightened by the Google debacle last week. With expectations low for 3Q earnings, positive surprises could be the catalyst that finally pushes the Dow & S&P 500 to new highs.