The U.S. stock market appears to be rewriting the usual economic playbook. While the economy shows signs of slowing down, company earnings are picking up the pace. This intriguing divergence could hold the key to continued stock market gains.
Recent analysis indicates that the combination of decelerating GDP growth and accelerating earnings per share (EPS) has historically created a fertile ground for stocks. This situation is not the norm, as GDP and EPS usually move in tandem. However, the current market seems to be an outlier.
Quantitative models suggest we’re in a strengthening phase of the stock market cycle. This is particularly interesting given that the S&P 500 is already near its all-time high. The divergence between EPS and GDP can be partly attributed to the composition of the S&P 500, which leans more towards goods than the broader U.S. economy. This bias aligns with the ongoing recovery in the manufacturing sector.
The second half of 2024 is expected to see a healthier manufacturing recovery, potentially boosting real demand and further driving earnings growth. However, this is happening against the backdrop of a slowdown in the services sector, which dominates the U.S. economy.
Revised estimates for first-quarter GDP, due out on Thursday, are expected to confirm this moderation in economic activity. This doesn’t necessarily spell doom for the market, but it does underscore the unusual dynamics at play.
Adding another layer of intrigue is the unexpected rise in consumer confidence in May. This could be a sign of resilience in consumer spending, or it could be a temporary blip. Either way, it’s a factor worth watching closely.
The market’s reaction to the news was mixed, with the Nasdaq Composite eking out gains while the Dow and S&P 500 slipped. Rising Treasury yields, fueled by the consumer confidence surprise and lackluster note auctions, added to the uncertainty.
Despite these mixed signals, the U.S. stock market has shown remarkable strength this year, with the S&P 500 posting an 11% gain year-to-date. The question now is whether this momentum can be sustained even as the broader economy cools down.
The answer may lie in the ongoing decoupling of earnings and GDP. If companies can continue to deliver robust earnings growth despite a slower overall economy, the stock market rally might have more room to run. However, investors should remain vigilant and watch for any signs that this unusual trend might be reversing.
