Chart Of The Day: Economic Policy Uncertainty
In recent weeks there has been an overwhelming surge of bullishness based on the idea that with the "fiscal cliff" issue now resolved, and the "debt ceiling" being pushed off well into the future, that the "uncertainty" that has been constraining business investment has now faded. The unleashing of the hoards of cash that have amassed on the sidelines in recent years should propel the economy back to above trend growth for years to come.
The problem is that while market participants have become wildly bullish in recent weeks the economic data has continued to either remain weak or get worse. Manufacturing has slowed, incomes have weakened and sales have declined. As far as businesses unleashing their hoards of pent of capital due to the reduction of economic uncertainty the latest NFIB survey still ranks poor sales, taxes and regulations as their top three concerns.
David Rosenberg recently addressed this exact issue saying:
"The Economic Policy Uncertainty index, jointly published by Stanford University and the University of Chicago, also does not portray a sudden upturn in optimism - having increased sharply in the past two months, event with the election behind us and the fact that the fiscal cliff was averted. Perhaps the payroll tax increase and what looms next with the debt ceiling fight and budget spending cuts are having an impact. Either way, the chart below would not ordinarily be consistent with sustained P/E multiple expansion, though clearly the Fed's ultra-cheap money policy has managed to distort a whole bunch of relationships between what is happing on Main Street and Wall Street."
Indeed, as for Main Street, we that the real GDP numbers from MacroEconomic Advisors showed a decline in each of the past two months (October and November) and contraction in the three of the past four months. The monthly data suggests that July represented the for real economic activity, and from then to November, GDP has receded at a 1% annual rate."
I have expanded on David's chart to include recessions and the S&P 500 index (logarithmic scale).
What you will notice is that peaks of economic uncertainty above 150 have generally coincided with either recessions or market corrections. With the market currently being driven to very overbought extremes on misplaced optimism about economic recovery there is a heightened risk to investors that is being disregarded.
The market is currently being pushed higher, not by economic improvements, but by the continual injections of liquidity from the Federal Reserve. The problem, of course, is that when the correction eventually takes place it will likely be far more severe than market participants currently expect. This has been the case post the last two rounds of Quantitative Easing which resulted in 20% corrections in the markets but no real improvement in economic growth. Caution is advised.