The Economy Is Better, So Why Is the S&P 500 Slipping?

The single best measure of the relative state of the U.S. economy when it is experiencing some degree distress is perhaps the number of publicly-traded U.S. companies that announce they are cutting their dividends each month. Through 12 June 2015, that indicator suggests that the U.S. economy has taken a positive turn beginning in May 2015, which we can confirm because the cumulative number of dividend-cutting firms in the U.S. in the second quarter of 2015 is now coming in quite a bit lower than the pace that was established in the first quarter, which experienced negative GDP growth:

Cumulative Announced Dividend Cuts in U.S. Stock Market by Day of Quarter, 2015, Snapshot on 12 June 2015

But you wouldn't know that's the case from the U.S. stock market, which has basically been slipping sideways or only slightly moving higher throughout the whole second quarter of 2015:

Alternative Futures for the S&P 500 - 2015-Q2 - Standard Model - Snapshot on 12 June 2015

The reason why the market has been moving sideways has to do with the complex nature of how stock prices work (described in math here), but in a nutshell, the explanation is this - while the U.S. economy is indeed performing better than in the first quarter of 2015, it hasn't translated into a robust improvement in the outlook for cash dividends expected to be paid out in future quarters.

Instead, the change in the year-over-year growth rates for each of the future quarters for which we currently have data (2015-Q3, 2015-Q4 and 2016-Q1) is such that stock prices are such that when we translate those expectations into the likely trajectories that stock prices are likely to follow, we find that they are much more likely to either continue moving sideways or to fall than rise, with the actual trajectory dependent upon the future point in time to which investors fix their attention.

That forward-looking focus appears to have become highly correlated with the U.S. Federal Reserve's plans for hiking short-term interest rates in the U.S. Here, the timing of when that might begin to happen has become a key driver for U.S. stock prices.

At present, the dynamics of that factor are as follows:

  • For a hike in 2015-Q3, stock prices would initially dip a bit, before resuming a largely sideways trajectory in the short term (through the end of June). This scenario would correspond to the Federal Reserve coming to the conclusion that the U.S. economy is performing so strongly that it must act to begin cooling it off.
  • For a hike in 2015-Q4, stock prices would move sideways to slightly higher in the short term. This scenario would correspond to the Fed seeing a slower rate of improvement in the U.S. economy.
  • For a hike in 2016-Q1, stock prices would fall sharply before stabilizing at a level about 5% lower than the current level. This scenario would likely play out if the Federal Reserve comes to the conclusion that the outlook for the U.S. economy is likely to slow down from how it began performing in May 2015, and might also be influenced by external factors, such as Greece's looming debt default in Europe and its effect upon global markets.

The wild card in this is that we do not yet know what the expectations are for dividends in 2016-Q2. We'll know more about what the stock market future associated with that quarter sometime next week.