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Investment Strategy

Screen Gems: Identifying Pockets of Strength

By Elliott H. Gue, on Oct. 23, 2014

From its intraday high on Sept. 19 to its intraday low on Oct. 15, the S&P 500 gave up almost 10 percent of its value—the biggest correction since 2011.

After pullbacks in 2010 and 2011, the point at which the S&P 500 climbed above its 200-day moving average marked an ideal opportunity to re-enter the stock market.

We expect the market’s most recent retrenchment to follow the same pattern; the S&P 500 closing above 1,906—the index’s 200-day average—would send a strong signal that the market should rally through year-end.

With the US economy continuing to strengthen, investors should regard recent weakness in equities as an excellent buying opportunity.

Economic Indicators Remain Bullish

The Bloomberg Economic Surprise Index quantifies how the past six months of US economic data stacked up relative to Wall Street’s consensus estimates. This index attaches greater weight to recent releases. Readings greater than zero indicate that, in general, economic data points have surprise to the upside.

(Click graph to enlarge.)BBerg US Economic Surprise Index

Although the Bloomberg Economic Surprise Index has pulled back from its recent high, the last negative readings came in early 2014, when disruptions related to the polar vortex distorted economic data.

Against this backdrop, we expect US economic growth to hover around 3 percent next year—well above the 2.2 percent to 2.3 percent expansion rate that’s prevailed over the past three years.

Published monthly by the Conference Board, the Leading Economic Indicators (LEI) incorporates the performance of 10 data sets that historically presage major directional shifts in US economic growth.

A negative year-over-year change in LEI has reliably warned of an impending recession since the late 1950s. On that basis, the economy appears to be on sound footing: This metric has increased steadily since early 2013, and in August 2014 climbed 6.8 percent from year-ago levels.

LEI Index

And over the six months ended August 2014, eight of the LEI’s 10 underlying components have added to the index’s overall value.

Manufacturing has been a bright spot for the US this year. The Institute for Supply Management’s New Orders Index—one of the leading economic indicators in the Conference Board’s index—stood  at 60 in September, near the high end of its five-year range.

Readings greater than 50 suggest that orders for manufactured goods are expected to increase; changes in the pace of incoming orders tend to lead shifts in factory activity by a few months.

Timing market corrections of 5 percent to 10 percent is notoriously difficult. However, strong US economic growth and a solid start to third-quarter earnings season should be enough to propel the S&P 500 to new highs by the end of 2014 or in early 2015.

Opening the Screen Door

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