Market Perspective for May 30, 2014

The S&P 500 Index climbed to a new all-time high on Friday, closing at 1,923.57. The Dow Jones Industrial Average, which is up 1.92 percent this year, is also on the verge of a new high, finishing out the week at 16,717.17. While the Nasdaq has been relatively weak for most of the year, during the month of May the Nasdaq rallied 3.1 percent and is now positive 2.12 percent year to date. Interestingly, the sub-index Nasdaq 100 is already at a new high. This indicates the Nasdaq has the strength to move higher and eliminate the last remnants of short-term bear resistance.

We have long expected the first quarter GDP estimate would be revised lower. Analysts were looking for growth to be approximately negative 0.5 percent, but the second estimate was even more disappointing announcement, falling to negative 1 percent. Even though the second estimate was worse, we also believed the market had already priced in the negative report. Moving forward, what is most important is the current Q2 GDP growth rate and the outlook for the remainder of the year. Many economists are still forecasting GDP will rebound strongly over the coming months.

One of the reasons for the weakness in GDP stems from an issue we discussed at the end of last year. In the third quarter of 2013, GDP growth was very strong due to a buildup in inventories. When the economy didn’t pick up as expected, the inventory overhang meant that companies didn’t have to produce as many goods to meet customer demand in the following quarters.

When GDP is calculated, inventory increases count towards GDP because a good was produced. When inventory falls, this subtracts from GDP. The large buildup of inventory in the third quarter of 2013 appears to have dragged on growth in the first quarter of 2014, and inventories fell. As a result of the drop in inventory, now there is the prospect of higher GDP growth in the coming quarters because companies will have to produce more to meet demand. Several investment banks have upped their Q2 forecasts: Goldman Sachs now forecasts 3.9 percent and Morgan Stanley forecasts a 4.2 percent growth rate this quarter. This is why the stock market indexes climbed to new highs when there was seemingly bad news about a contracting economy.

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