Stocks over-discount economic recovery

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The graph below from Citi economist Steven Wieting (courtesy of Clusterstock – Business Insider) conveys a message I have been propagating for a while, i.e. that stocks have moved up too quickly relative to the pace of the economic recovery.

Being a forward-looking mechanism it is common for the S&P 500 Index (red line) to rebound ahead of industrial production (blue line), only to then stall or correct as the economy plays “catch up”. Whichever way I look at the fundamentals, stocks on this occasion have undoubtedly priced in more than what economic growth, and corporate earnings, can deliver in the foreseeable future.

In short: The gap between the red and blue lines on the right-hand side of the chart has become too stretched and and stocks therefore require a much-needed consolidation/pullback as we are now witnessing.

Source: Clusterstock – Business Insider, May 5, 2010.

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