Stocks and the Economy Still Diverge

 | Jun 13, 2013 | 6:00 PM EDT
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In the increasingly fast-paced world of technology-driven financial media, the crisis of the day is forgotten as quickly as it arises. This has been made clear repeatedly with respect to federal budget issues since the budget fight in the summer of 2011 resulted in dire predictions of U.S. sovereign defaults and the passage of the Budget Control Act of 2011.  

That legislation provided the plan for across-the-board federal spending cuts, called sequestration, that began to be phased in on March 6 of this year, about three months ago.

Concerns from the media and from individual investors about the impact of the cuts on the economy and financial markets peaked at about the same time the cuts went into effect. These concerns quickly disappeared almost immediately everywhere, except in the D.C. area.

The stock prices of the largest government contractors have continued to rise throughout the last few years, despite media talk of fiscal cliffs, debt ceilings and gridlock.

I last discussed this on April 3, at about the time the media's interest in sequestration was at its maximum, in the column "For Defense Stocks, Crisis Is a Cushion."  

One of the points I noted in that column was that the then-occurring outbursts by North Korea would help bolster government contractors' stocks. But that issue has come and gone too, while the contractors stocks continue to rise.

Since that column appeared, Lockheed Martin (LMT), the largest government contractor, has gone from $95 to $107, a 12% rise.

Northrop Grumman (NOC) has gone from $70 to $83, a 19% increase.

Boeing (BA) has risen almost 21%, from $84 to $102.

Raytheon (RTN) has moved up by 16%, to $67.55 from $58.

General Dynamics (GD) has increased almost 15%, from $68.39 to $78.25.

These are huge increases, and with the exception of General Dynamics, all are either near or above the levels that prevailed before the 2008 crisis.

Setting aside the sequestration and budget issues, this has been happening even as bond yields are rising, the markets are concerned about the Fed's quantitative easing being removed and the growth rate in private-sector economic activity and government spending on defense continues to slow.

Anecdotally, it appears that the interest in these stocks is being driven by their size and dividend yield.

In the past few months, Doug Kass and James DePorre have had a few back-and-forths on the divergence of negative economic fundamentals and simultaneous positive equity-market performance.

The apparent detachment between the economic trajectory for both the private and public sector and the performance of equities cannot continue perpetually.

One of two things must eventually occur. Either economic activity must increase to warrant the equity run that preceded it, or stock prices must fall to meet the economy.

In my opinion, equity prices, in the government contracting space at least, are now reflecting a best-case scenario of an imminently expanding economy and a federal budget deal that ends sequestration without cutting defense spending.

I don't think that either of those is likely. 

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