Economic Expectations Are Too Gloomy. What That Means for Stocks.

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Economic data have been missing expectations frequently of late, but several indications say that is about to reverse. That would be a boon to the stock market.

The Citigroup Economic Surprise Index—a score that measures the degree to which economic data is beating or missing estimates—has fallen into negative territory for the first time during the recovery from the pandemic-induced recession. It was recently at negative 37, compared with a recovery-period peak of just over 250. 

The key factor behind the plunge and the economic weakness it signals has been the Delta variant of Covid-19. The latest outbreaks have cut into industrial production abroad, not to mention partly closing one of China’s biggest ports, making it difficult for companies to access the supplies needed to meet demand.

That has contributed to concern that inflation, already a worry given the trillions of stimulus dollars the U.S. government has pumped into the economy, might erode consumer demand. Economists now expect that inflation-adjusted growth in U.S. gross domestic product will be around 6% for 2021, down from 6.5% in June, according to RBC Capital Markets. 

The Economic Surprise index is now lower than it has been for 80% of its entire history, according to data from The Leuthold Group. The index has fallen even though the yield on 10-year Treasury debt has risen this month. Increases in yields, which signal optimism, historically have come about five months before economic data begin beating expectations, according to Leuthold. 

And during those five-month periods, the

S&P 500

has risen at an average annualized rate of 31%.

To be sure, stocks’ path is unlikely to be smooth. Analysts are raising their forecasts of earnings for fewer companies, and

Bank of America

sees the recent weakness in economic activity as ominous for stocks. A correction could be on the way.

But that doesn’t mean the market can’t prevail over a period of many months, especially if the economy is fine. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com