Market Wrap-up for July 2 – Improving Economy Could Mean Diminishing Market Returns

This morning’s ADP jobs number came in much better-than-expected, but here’s why an improving economy could actually signal the end of the equities market’s historic run.

Continuing a string of data points indicating a slowly but steadily improving domestic economy, U.S. companies added 281,000 private sector jobs in May. This number blew analyst expectations of 205,000 out of the water. Yet the markets are barely reacting today, and they’ve generally yawned at most recent positive economic signals, instead tending to rally on days largely devoid of major news items. Here are four reasons why investors should be cautious amid an advancing economy.

1. The Market Always Gets Ahead of the News

Literally years before economic data began improving, investors began making bets that it would improve. It had to eventually, of course – the recession of late 2007 through mid 2009 was really bad. It was only a question of how long it would take for the economy to return to “normal” levels.

Point being, the markets are always looking ahead. It doesn’t matter what’s happening now, it’s all about the perception of what’s going to happen in coming months and years. Once the powers that be see trouble on the distant horizon, the selling will start, just as the buying began in 2009 amid the faintest glimmer of hope. This means that we see rallies amid worsening data, and sell-offs amid improving data. Which brings us to our next point.

2. The Market Is Disconnected from the Actual Economy

Stock prices are a function of simple supply and demand. More bulls than bears? Market goes up. More bears than bulls? Market goes down.

While the economy is an ancillary part of the market–meaning it provides a backdrop upon which investors base their decisions–the long-term growth of the market far outpaces the actual economy by a large multiple. Speculation also runs rampant during bullish cycles, and corrections don’t last very long before the next wave of euphoria washes back over the markets. But those corrections are where the big money is made – and lost.

3. A Fed-Fueled Market Means if Accommodation Declines, so Will Stocks

There’s no question that the unprecedented amount of economic accommodation forced upon the markets by central banks and other regulatory agencies across the globe has had a major bullish effect. The banks and automakers were bailed out, the government began buying its own bonds, unemployment was extended to two years, etc., etc. We’re talking trillions of dollars committed to saving the economy. Why wouldn’t the markets rally in the face of such a clear message?

The message, of course, is that the government will take whatever measures necessary to pump enough liquidity into the system to “fix” it. Well, what happens when it’s “fixed”? When the message turns from “We’re still worried about the economy” to “We’re turning off the spigots soon,” expect major sell-offs to occur.

4. Sentiment Can’t Get Any More Bullish

Just about every investor sentiment indicator you can find indicates an overwhelmingly positive attitude towards the markets. For example, CNN Money’s Fear & Greed Index is at 90 out of 100 right now. Even blowout employment and housing data can do little to push sentiment any higher than it already is.

As we touched on earlier, the markets have repeatedly yawned at improving economic data. So where are the additional bullish catalysts needed to maintain these lofty asset prices?