Stocks versus the economy...

As of yesterday, 283 of the companies comprising the S&P 500 have reported 2nd-quarter earnings—67% beat analysts estimates. Add to that the fact that earnings thus far have grown at a rate of 10.5%, with revenue up 5.1%---against consensus estimates of 6.2% and 3% respectively---and you should be feeling pretty good about the present state of corporate America.

As for the economy, here's the first sentence of my note to self (after summarizing recent economic data) day before yesterday: "On balance, I feel strongly that the U.S. economy is on firm footing and will expand at a greater than recent pace into next year." Then yesterday's note: "Today's numbers basically confirm my latest commentary; that things are indeed looking up. In terms of 2nd-half GDP, if the consumer remains as confident, it'll reflect in the consumption metric, which accounts for 70%."

The numbers (in a nutshell) are telling us that business conditions (across the supply chain) are improving and that the consumer is expressing a high (relative to recent surveys) level of optimism about the future.

And then there's today's first reading on 2nd quarter GDP, which came in at a whopping 4% (inflation adjusted [6% nominal]) annualized. A substantially greater growth rate than the consensus estimate. Underneath that number we had consumer spending up 2.5% (biggest increase in 5 years), business investment up 5.9%, and a 1.7% growth in business inventories. The price index rose a relatively non-threatening (moving higher nonetheless) 2% (if this spells a trend, the Fed will start looking sooner than currently expected at moving short-term interest rates higher).

(CAUTION on the GDP number: This is the first Q2 estimate (not all the data is in). There'll be a revision in August, then the final reading in September. Q1's first reading came in a .1%. Its final reading was -2.9%.)

So, very good earnings results, and, finally, the economy is clearly coming to life. And of course the stock market is rallying big time today on all this wonderful news, right? Well, the Dow did rally to up 70 on the GDP number, however, as I type it's down 84. Hmm...

So what gives? From my summary paragraph on Monday:

"My take (July 28): On balance, I feel strongly that the U.S. economy is on firm footing and will expand at a greater than recent pace well into next year. With regard to stocks, intuitively, a growing economy should bode well for equities, even at current valuations. However, should the economy surprise to the upside (grow yet faster), and should wage pressure begin to mount, the stock market will likely have to contend with a fast pace of rising interest rates/sell-off in bonds. Given how the world's central banks have effectively hijacked the bond market, we just don't know what happens when it finally breaks free."

The stock market is clearly struggling with the prospects for higher interest rates. However, many a pundit has been predicting of late that the market will hold up well against higher rates due to the simple fact that they (rates) will move higher on the back of a growing economy. Makes sense. And there is, per the chart below (click the "S&P 500 vs interest rate" link), some historical support for the notion that higher interest rates don't necessarily have to bring down the stock market. However, as I suggested above---and as recent volatility around fears of Fed tightening indicates---this time, at least at the onset of rising rates, things might not go the way the optimists expect.

Beyond a potential initial hiccup, or belch, or vomit, resulting from a spike in interest rates, continued business expansion and better earnings---barring a zillion potential exogenous events---could indeed bode well for stock prices going forward. 

S&P 500 vs interest rates

As for bonds, I wouldn't touch em right here. Here's a look (click the link below) at why:

bond fund price vs interest rates

Stay tuned...