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A Stock Plunge Amid Strong Economic Data

While the stock market plunged to open the fourth quarter of 2014, much of the key economic data pointed to accelerating economic momentum.  While a stock market correction was overdue -- we had not experienced a 10% drop in over three years -- the economic data upon which stock prices are based remained strong. Consider the follow facts: 

The two purchasing manager indices tracked by the Institute of Supply Management (ISM) were both above 55.  A reading of 50 or higher indicates economic expansion. Moreover, sub-indices measuring new orders, which are the forward-looking components of the monthly surveys of purchasing managers, were at 60 or better.  These are extremely strong readings and indicate healthy production in manufacturing and non-manufacturing is ahead. 

Car sales, meanwhile, surged during the summer and home construction is gradually trending higher. Household net worth has fully recovered to slightly above its longer-term growth trend and the Federal Reserve's key measure of consumers' ability to spend money shows that the American consumer's ability to cover their monthly nut has rarely been better. 

Household deleveraging, ongoing since the debt 2008 crisis, is now completed.  Personal income and spending have been trending steadily higher, gasoline prices dropped $.40 per gallon during the summer, and bank lending surged.  September's new jobs data on both of the government's monthly surveys were encouraging.

In early September, The Wall Street Journal surveyed approximately 50 economists on their quarterly GDP growth forecast through 2015.  The resulting consensus forecast is illustrated in the following chart. Economists generally see close to 3% gross domestic product growth ahead.

The array of forward-looking economic data captured by the index of leading economic indicators released September 19, 2014:  expect the healthy pace of economic growth to continue for now.

Beyond 2015, the bigger picture on the economic outlook, according to the Congressional Budget Office's August 2014 release of its 10-year economic forecast, indicates U.S. economic gross domestic product (GDP) will ultimately revert to its long-term track, and the U.S. gradually will return to full employment. 

Similar to the near-term forecast for U.S. GDP growth, the IMF's October global economic forecast showed expected acceleration in economic growth in 2014 and 2015 in all major regions of the world, except Japan and China, with China holding about steady at +7.1%.  Significantly, despite the recent headlines about recession possibly returning in Europe, the European economies continue to recover and are expected to return to healthier expansion next year. 

As stocks plunged in mid-October, the anchors and guests on financial TV shows and channels breathlessly described the drop.  Even CNN, which is usually less shrill, said the latest economic data was "mediocre."  Try not to take the talking heads on TV too seriously. In fact, the stream of improving economic data over the last several years explains why stocks have run steadily higher without even so much as a -10% correction. 

No one can predict when stock market investors will change their sentiment.  But in the long run, it is economic fundamentals that matter most to stock prices, and the fundamental data showed no signs of a recession heading into the October's plunge.

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