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Surprise! The Economy Is Beating Forecasts Again

The Wall Street Journal logo The Wall Street Journal 10/31/2017 Chelsey Dulaney

The U.S. economy is outpacing expectations for the first time since April. What that means for the stock rally is a matter of debate.

Citigroup 's U.S. Economic Surprise Index, a widely-used tool used to gauge how economic data matches up to expectations, has risen to its highest level since April in recent weeks. As The Wall Street Journal’s Morning MoneyBeat newsletter noted Tuesday, a number of better-than-expected readings on the economy--from third-quarter gross-domestic product to manufacturing activity--helped pull the index out of negative territory in October for the first time since spring.

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Analysts at PNC Asset Management Groups said the index’s recovery-- which indicates economic data is coming in above forecasts--is due in part to "analysts’ predictions becoming too dour in the middle of the year." The recovery in global growth is also helping the index, PNC said.

More positive economic surprises have helped bolster the U.S. stock market since 2016, said James Paulsen, chief investment strategist at Leuthold Group, in a research note last week. Though the index doesn't measure economic growth, positive readings can be an encouraging sign for investors who often respond to how data stacks up to expectations rather than the data itself.

Mr. Paulsen believes better-than-expected economic data will keep the stock rally afloat through the end of year. But the dynamic could begin to shift next year.

A proxy for how supportive economic conditions are to growth--derived from changes to the value of the U.S. dollar and U.S. Treasury yields--is signaling the economy could begin to lose momentum next year, Mr. Paulsen said. That could spell trouble for the U.S. stock rally.

To be sure, few analysts are calling for a big market downturn or economic meltdown. And Citi's index hasn't always been a reliable indicator of where stocks are going. Case in point: U.S. stocks have continued to power higher in recent months even as the index fell into negative territory.

But even if the economy maintains its slow-but-steady pace of growth, Mr. Paulsen warns: “Without chronic positive reinforcement from the economy, the stock market could struggle.”

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