A data dilemma
In the wake of last year’s U.S. presidential election, a significant divergence emerged between the “soft” economic data – surveys and measures of sentiment – and the “hard” economic data such as industrial production, retail sales, and gross domestic product. This divergence was initially ignored as both equity prices and interest rates moved higher, but began to garner attention as the hard data continued to disappoint over the course of the first quarter. This, along with rising geopolitical tensions, led equities to pause and put downward pressure on Treasury yields.
The soft data is cooling, will the hard data heat up?
EXHITIB 1: BLOOMBERG U.S. ECONOMIC SURPRISE INDEX, SOFT VS. HARD DATA
Source: Bloomberg, Citi, J.P. Morgan Asset Management. This chart shows the Citi Economic Surprise Indices, which track how economic data is doing relative to expectations, for composites of "soft" and "hard " data. The soft data index includes consumer and business surveys. The hard data index includes actual economic data on the industrial, housing, retail and household sectors and on the labor market. Data are as of April 26, 2017.
As shown in Exhibit 1, the soft data has begun to cool, but divergence from the hard data is still notable. 1Q17 real GDP growth was weak, coming in at an annual rate of 0.7%, but it is important to remember that in a given quarter, strong economic growth is not a necessary condition for the stock market to rise. Furthermore, expectations for profits – the long term driver of stock prices – are that earnings growth was positive on both a quarter-over-quarter and year-over-year basis. This marks the third consecutive quarter that profit growth has been positive.
In sum, although the first quarter economic data showed some signs of weakness, the profit story remains intact. Profits fall into the hard data camp, and the rebound in earnings growth that we are seeing should support a gradual rise in U.S. equities over the remainder of 2017.