Mixed Message: Economy Shrinks Most Since 2009, Nasdaq Hits 14-Year High

Yesterday, stocks fell despite top-notch economic data. So it only makes sense that stocks rallied today, despite an array of disappointing numbers.

AP

The S&P 500 rose 0.5% to 1,959.53, while the Dow Jones Industrial Average advanced 0.3% to 16,867.51. The Nasdaq Composite advanced 0.7% to 4,379.79–its highest close since April 2000–and the small-company Russell 2000 jumped 0.8% to 1,182.68.

Oh, but the news was so, so, disappointing. Today we learned that US GDP contracted 2.9% during the first-quarter, the biggest growth slump since the first quarter of 2009. You might argue that GDP is backward looking–and it most certainly is if we’re still talking about the first quarter near the end of the second–but durable goods orders are much less so, and they fell 1% in May from April.

RBC Capital Markets’ Tom Porcelli notes that the poor GDP number means the U.S. will be stuck growing at a 2% clip–again–in 2014. He explains:

The final analysis on Q1 from our perspective is that this was as much a weather-induced bump in the road as it was the economy hitting the reset button following a 2013 H2 where growth clocked in at an unsustainable 3.3% average. This result creates a very low hurdle for Q2 activity and we marked our best guess a full percentage point higher to closer to 4.5% following the softer Q1. But for all of the sound and fury, what we are left with is US economic growth that over the four quarters ending in Q2 of this year that averaged… wait for it… 2%! Effectively we have been growing at what has been the cyclical speed limit of this expansion. So spelling out the obvious, Q1 is not reality any more than the expected Q2 bounce is reality. And once the dust settles from this noisy H1, economic growth will sit pretty much where it has for the last few years – right around 2%

Still, stocks jumped. And yet, says Capital Economics’ John Higgins

The gains in stock markets over the past five years have obviously made them less attractively valued. But we think there is little evidence of "bubbles".

Take the S&P 500. It has more than trebled since the spring of 2009, driving up the ten year cyclically adjusted price/reported earnings ratio from 12 to 26. This is clearly a big increase. But the ratio has been a lot higher in the past: it topped 44 at the peak of the dot-com bubble. Granted, the ratio is now nearly 70% above its average since 1881, which some would say also constitutes a bubble – just a smaller one. But the ratio is inflated because reported earnings collapsed during the last recession. When these are substituted for operating earnings, and an adjustment is made for changes to firms' payout policy, the degree of overvaluation reduces to a less alarming 30%.

What's more, various factors – such as lower and more stable inflation than in the past – may have raised the equilibrium level of the ratio over time, so the true degree of overvaluation is probably even less. Applying the same changes and comparing the current level of the ratio to its average since 1960 suggests the market is only about 20% overvalued.

Only 20%. Wow. Nearly a bargain.