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July 03, 2014 at 08:33 AM
After a long winter put a damper on the U.S. economy in the first quarter, job growth is finally heating up.
“Spring arrived, and fortunately, so did the economic snapback,” said LPL Financial Research in its midyear outlook report, released earlier this week.
Indeed, some 288,000 jobs were added in June, the Labor Department reported Thursday, and the unemployment rate fell to 6.1%.
The markets, of course, reacted favorably to the latest job news. The Dow Jones industrial average moved toward 17,040 as the S&P 500 topped 1,980 ahead of the July 4 holiday.
Analysts at LPL Financial (LPLA) say we’ve reached a moment of truth: “If the economic data continued to weaken, it would mean that something was more deeply wrong with the economy than merely the weather. If spring led to a rebound, then it meant the weakness in the first quarter was weather related, and our forecast for a breakout in the economy to a faster pace of growth was still on track.”
What can keep the momentum alive for the economy and markets? Here’s a look at four factors highlighted by LPL Financial research analysts in their recent midyear outlook report.
1. The Treasury Yield Curve
Market participants “have become worried about when the Fed may start hiking short-term interest rates,” the LPL research team explains. Many of them expect the Fed to begin rate hikes in 2015.
History, though, “shows that the start of rate hikes does not really matter that much to stocks after an initial dip and quick recovery. Instead, bull markets end and bear markets begin when the Fed pushes short-term rates above long-term rates. This is referred to as ‘inverting the yield curve.’ ”
Why does an inverted yield curve signal an important peak for the stock market?
Every recession over the past 50 years was preceded by the Fed hiking rates enough to invert the yield curve, the research team says: “That is seven out of seven times — a perfect forecasting track record.”
The group notes that the yield curve’s inversion tends to take place about 12 months before the start of the recession, though the lead time can range from about five to 16 months.
“The peak in the stock market comes around the time of the yield curve inversion, ahead of the recession and accompanying downturn in corporate profits,” the LPL Financial team explained in their outlook report.
To invert the yield curve by 0.5%, the Fed needs to hike short-term rates from around zero to more than 3%, it adds.
“Based on the latest survey of current Fed members that vote on rate hikes, they do not expect to raise rates above 3% until sometime in 2017, at the earliest,” the report said. “The facts suggest the best indicator for the start of a bear market may still be a long way from signaling a cause for concern.”
2. The Index of Leading Economic Indicators
The Index of Leading Economic Indicators (LEI) is put together by the Conference Board. It includes 10 fundamental economic indicators and aims to predict the future path of the economy, with a lead time of between six and 12 months.
When the year-over-year rate of change in the LEI turns negative and begins to fall, a recession has historically followed by anywhere from zero to 14 months, the LPL Financial report says. (In other words, the LEI serves as an early warning of a recession.)
In April, the year-over-year increase in the LEI was 5.9%.
“On balance then, we would agree with the statistical evidence of the LEI that the risk of recession in the next 12 months is small at about 4%, but not zero,” the outlook analysis explained. “The LEI suggests the U.S. economy is in the middle of the cycle that began in mid-2009.”
