Don't Look Down!

When climbing a mountain or standing on the edge of a precipice the old axiom "Don't look down holds water."  This apparently also works in children's cartoons where the character pursuing, in this case Wiley E Coyote, is fine until he looks down and realizes that there is no floor.  Only then does he plummet to the bottom of the canyon.

The same can be said of the market.  The first quarter GDP numbers were terrible.  Having initially estimated growth of 0.1% it was revised to show a decline of 1%.  Worse still corporate profits fell 9.8% which was the worst decline since the Great Recession began.  It really did not matter where you looked on the corporate profit side as both domestic and foreign sourced profits were weak in both financial and non-financial sectors.  There was no hiding but for some reason the market continued higher with the S&P 500 printing new all time highs.  It appears that either the coyote is standing on an invisible platform or the market has not yet looked down so which is it?

Looking at this in some more detail it appears that the market is betting on a resurgence in the second quarter.  Economists across the board (including the Federal Reserve) expect that GDP will accelerate in the second quarter.  Estimates as high as 4% are being touted and the market has bought into these estimates.  The view is that the cold winter kept people away from buying and that this pent up demand will be reflected in the second quarter GDP growth.  So is this plausible?

Well so far the second quarter is not living up to its hype.  Housing sales (the one area that economists firmly placed their bets) has not rebounded.  What has remained strong is spending on health care which grew by 9.1% (so much for savings in the health care sector associated with Obamacare) and this trend is likely to continue. The squeeze is on and consumers are feeling the pain.  On top of that oil continues to move higher breaking above its 52 week high and the follow on in gasoline prices is hurting consumers further.  This is having a direct correlation to spending which while higher is being poured into health care, food and gasoline rather than housing, technology and other consumer items.

So to me once again the market is being promised something (4% GDP growth) that is not there.  I would be surprised to see GDP above 2% in the second quarter.  Anything below 2% would be a huge disappointment and would send the markets reeling but there is one last caveat - the Federal Reserve.  If I am right and GDP is weak in the second quarter it would be equally surprising to see the Federal Reserve continue to cut their purchases.  This is the second hope of the market.  The bulls believe that they will be rescued regardless of what happens so they are relying on the invisible platform and are not looking down.  I on the other hand have decided to stand well back from the ledge's edge and suggest that you do the same.