Dow Rally, Job Growth Face A Capital Expenditures Time Bomb

June 17, 2020 8:36 PM UTC
Dow Jones bulls are cherry-picking economic data, like pent up demand in retail sales bursting, to justify valuations that don't match the economic fundamentals.
  • The Dow hasn’t given up on its six-week rally after last week’s slip.
  • But lagging capital expenditures means the economy is far from recovered.
  • That may leave stock market bulls who are buying into this rally holding an empty bag.

The Dow Jones Industrial Average is back to the 12-week rally this week after a brief interruption. That’s fortunate for investors. They might have nowhere else to seek profits but stocks in this zero interest rate, low yield environment.

The bull run on equities continues after a steep selloff last week that gave investors flashbacks to March. But strong retail numbers put a quick end to the brief pullback. While markets and policymakers expected this resurgence in pent up demand, one leading indicator of economic growth could mean less wind in the Dow Jones’ sails ahead.

Businesses Are Running Tight on Costs

Cracks in the economy are starting to show. | Source: Twitter

Capital expenditures hardly rebounded in May compared to the retail sales numbers. That means corporations are still cutting back maintenance and investment in new property and equipment. It signals corporate finances are still shaky despite unprecedented federal emergency aid and Federal Reserve money pumping. That’s not a good sign for the job market or the multi-trillion dollar business to business market.

It also means profitability numbers in Q2 earnings reports will look better because companies slashed spending on capital expenditures and were slow to return it to previous levels. But the underlying businesses will look stronger on paper to bullish investors eyeing the earnings line than they really are.

If the economy continues to lag in recovery, that could set up stock market benchmarks like the Dow and S&P 500 Index for a grueling correction. That will give the stock market a boost in the short term, but in the long term stocks will face a reckoning with what’s going on in the economy.

Companies are investing less in productive capital, and are, potentially, in rough shape to continue hiring. Notice on the CAPEX graph, the period of positive CAPEX Expectation coincides with massive job growth. Capital doesn’t compete with labor, it increases the value of labor. That pushes up wages and creates job opportunities at the same time.

Any critic of stock buybacks can tell you that jobs and growth can suffer when companies forego spending on productive capital to expand their business.

Dow Bulls Are Cherry Picking Data

The stock market bulls pushing the Dow, S&P 500, and NASDAQ Composite dizzyingly higher are cherry-picking retail sales data to continue the equities melt-up. One month of pent up demand that everyone expected does not mean the economy is out of the woods yet.

The continued belt-tightening around capital expenditures indicates persistent corporate financial distress. The recovery may be more slow and painful as a result, than the stock market is pricing in at the moment. And even if it wasn’t, valuations are already at many historical extremes. This weekend even Jim Cramer called it “the most overbought market in history.” But if recovery comes slower than analysts are hoping, the Dow level will sink back to reality.

The Federal Reserve just grew its balance sheet by $3 trillion in three months. When the Fed dumps half the ocean into financial markets, don’t be surprised to see froth in highly traded equities like blue-chip Dow stocks.

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.

Aaron Weaver edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

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