Should We Worry More About The US Economy Or The International Economy?

May 14, 2014

By Knowledge Leaders Team in Uncategorized

The KBW Bank index is an index of 24 commercial banks in the US. It is considered a good proxy of the banking sector. Commercial banks tend to draw most of their profits from the local market, so the performance of the KBW Bank index is a decent proxy for profit expectations of the domestic sectors of the US. Likewise, the S&P 600 small cap index is an index of small cap companies, and small cap companies tend to derive more of their profits from the domestic economy (rather than international operations). So, if there are concerns about domestically generated profits in the US, likely the KBW Bank index and the S&P 600 small cap index will underperform the S&P 500. This is exactly what is happening now. In the chart below we compare the relative performance of the KBW Bank index to the S&P 500 and the relative performance of the S&P 600 small cap index to the S&P 500.

As a double check, let’s bring into the analysis some other proxies for domestic and foreign strength. Lumber is used primarily for housing and so serves as a good proxy for the health of the housing market narrowly, but of the domestic economy more broadly. Copper tends to be used in infrastructure and durable goods, so it serves as a good proxy for the health of the international market (especially given the huge infrastructure spending in the emerging markets). By making a lumber-to-copper ratio, we can then broadly measure the relative strength of domestically oriented sectors compared to more internationally oriented sectors. Interestingly, the lumber/copper ratio has flatlined for the last year and appears to be starting to roll over. Below, we compare the lumber/copper ratio to the S&P600/S&P500. The message here seems to be one of a growing relative concern of the domestic economy over the international economy.