Looking back at how stocks have behaved this month, one has to concede that the "Sell in May and Go Away" advice had a lot going for it. But as is always the case, things are a lot more complicated than that. More than mere seasonality, there are plenty of sound fundamental reasons for the market’s recent bout of tentativeness.
While there is no shortage of issues beyond the U.S. shores, the key concern pertains to the growth outlook for the U.S. economy. Is the U.S. economy accelerating from the first quarter’s tepid growth pace of 1.8%? Or is the economy on track to expand in the current quarter at a pace that is roughly inline with what it did in the first quarter?
The tone and substance of recent reports is not supportive of second quarter growth surge. Consumer spending is weighed down by high fuel costs, though prices may have already hit a seasonal peak and will likely drift down in the coming days. Housing is effectively in a double-dip downturn and has again become a drag on the economy. But more worrying is the decelerating trend in the nation’s industrial and manufacturing sector, which had thus far been a stand-out performer in this recovery.
The manufacturing slowdown may be reflecting the cascading supply-chain disruptions from Japan’s disaster, in which case it should be a temporary pause. We will get a better read on the manufacturing picture next week from the Chicago PMI and ISM Manufacturing reports.
But not everything is doom and gloom either. A major positive for the economy at this stage is the labor market turnaround. All empirical and anecdotal evidence is pointing to a steadily improving trend in the employment picture. A consolidation of this trend line in the coming days will help offset the soft economic readings referred to above and put the economy on a far more sustainable growth trajectory.
Job gains will not only help improve the consumer spending outlook, but will also give a favorable nudge to the beleaguered housing market. Thursday’s surprise upturn in Jobless Claims was not a good sign. But we will get a more definitive read on the labor market next week as we get the May non-farm payroll numbers.
All in all, the U.S. economy appears to be on a below-trend growth pace of about 2% in the second quarter. But if the labor market continues to improve, then the growth rate should accelerate in the second half of the year.
And as we saw in the first quarter, the corporate sector is more than capable of sustaining the earnings trend even in a below-trend economic growth backdrop. As such, even as GDP growth estimates for the second quarter start trending down in the coming days, earnings estimates should stay firm.
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