'Stealth' Economic Slowdown Is Bad News for Stocks

Investors are unduly optimistic about the economy and stocks, according to Lakshman Achuthan, co-founder of the Economic Cycle Research Institute, in remarks on CNBC. Once extremely bullish, he now warns that "There is a stealth slowdown already happening." In particular, he notes that real, inflation-adjusted, consumer spending and income growth have been "rolling over," or slowing down. "That points to a fresh softening in a big part of the U.S. economy," he says. Another source of worry for Achuthan: "Spending is outpacing income growth. That puts a lot of pressure on consumers, especially if interest rates are starting to rise." His conclusion is that stocks are "cruising for a bruising." (For more, see also: 8 Threats to the Market in 2018.)

Fragile Market

The S&P 500 Index (SPX) fell by 10.2% in a correction from its all-time record high close of 2,872.87 on January 26 to its low close of the year on February 8. Looking strictly at closing values for the index, it came within a whisker of that low on March 23. The closest approach to the high was on March 9, when it fell short by 3.0%. On May 23, the S&P 500 ended trading 4.9% below the January 26 high.

The recent behavior of the CBOE Volatility Index (VIX) presents a potentially worrisome "disconnect" in the market, per a second CNBC story. Dennis Davitt, a partner at options-focused investment firm Harvest Volatility Management, is concerned that the VIX, often called a fear gauge for the market, did not decline as much as it typically would during the rally on Monday, May 21. He takes this as evidence that investors are skeptical about the staying power of market rebounds right now, especially given unresolved trade tensions between the U.S. and China. If the VIX fails to decline significantly during a market upswing, Davitt would interpret that as a bearish signal.

Asset Value Prop Removed

More words of warning were voiced by Neil Dwane, global strategist at Allianz Global Investors, in another CNBC report. He believes that the markets have yet to fully grasp the fact that central banks around the world are ending their programs of quantitative easing that have propped up asset prices. "We are concerned the market is understating the impact of quantitative tightening, particularly in the U.S.," he said, with the ominous addendum that "I am dancing closer to the fire exit than I have been for some time." (For more, see also: Stock Market's 'Absurdly Good' Returns Will Worsen in 2018.)

Rising interest rates mean both higher borrowing costs for companies, and thus lower earnings, as well as lower stock returns relative to bonds, both of which are negatives for stock prices. Also, anticipated future earnings on stocks will get discounted at a higher rate, decreasing their present value, and thus exerting additional downward pressure on stock prices. Finally, stock valuation multiples, such as price-earnings (P/E) ratios, may drop as a result of higher interest rates.