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US stock market out of sync with economy

US stock market out of sync with economy
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First Published: Tue, Apr 24 2007. 12 27 AM IST
Updated: Tue, Apr 24 2007. 12 27 AM IST
The US stock market used to be full of nervous souls. Hence, Paul Samuelson’s famous quip that it had forecast nine of the last four recessions. This reputation for jittery anticipation is at risk. There are plenty of signs that the US economy is heading for trouble. Yet the Dow Jones closed on Friday (20 April) at nearly 13,000, its third straight record. The index is up by nearly 6% since the beginning of the year. The stock market, it seems, is no longer a leading indicator but a lagging one.
The list of woes afflicting the US economy keeps getting longer. New housing completions fell by a massive 20% in the first quarter, compared with a year earlier. Business investment has also declined. Retail sales are slowing and exports have dipped. Analysts have slashed their expectations for earnings growth of S&P 500 companies in the first quarter from 9% at the beginning of the year to a mere 3%. Equity strategists at Dresdner Kleinwort expect the US will enter a full-blown “profits recession” in the second quarter.
Economic growth slowed to 1.5% in the first three months of the year, estimates Merrill Lynch. In February, the Conference Board’s index of leading indicators dropped below its level of a year earlier. A negative reading by this measure has accurately anticipated every recession over the past 40 years, with no false positives. The inverted yield curve also suggests the US economy is set to contract.
Yet none of this negative information is reflected in the stock market. That’s because investors aren’t so concerned about the outlook for profits. All they care is that buyouts and buybacks should continue to buoy the market. In aggregate, probably more than $200 billion (Rs8.4 lakh crore) worth of stocks were retired by these means in the first quarter. These purchases were largely funded with borrowed money rather than earnings.
The stock market, however, can’t remain disconnected from the economy indefinitely. Debt-financed stock repurchases depend on low credit spreads, according to London-based economic consultants Smithers & Co. But credit spreads are likely to rise if profits go into decline. If that’s right, investors could be the last ones to know when the next recession finally arrives.
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First Published: Tue, Apr 24 2007. 12 27 AM IST
More Topics: Money Matters | Global Markets |