An economic growth reacceleration is vital to sustaining the U.S. equity rally and P/E expansion from the February lows. So far, no such confirmation has materialized. Instead, the U.S. appears to be edging closer to a growth scare according to our equity strategists.
Now that U.S. profit margins are narrowing more rapidly and top-line growth remains non-existent, there is a more urgent need for companies to retrench. As seen in the chart above, leading indicators warn that consumption, investment, manufacturing and employment all have the capacity to disappoint in the second half of the year.
Ominously for equity markets, the Fed continues to harbor a deep desire to lift interest rates from what it still considers to be emergency levels at a time when the economy is nearing full employment. Consequently, financial conditions could tighten anew, exacerbating an already challenging profit outlook.
As discussed in the next Insight, several market indicators suggest that the Fed is too complacent about the downside risks to growth.