ANALYST: There's A Big Red Flag In The Economic Data That Could Set Up Stocks For A Nasty New Year's Surprise

The latest divergence in economic data may be setting up the stock market for a "nasty New Year surprise," says Andrew Wilkinson.

Wilkinson, the chief economic strategist at Miller Tabak, highlights two interesting charts in his latest note to clients, recreated here.

The first is the Citigroup Economic Surprise Index (CESI), which measures how good the economic data comes in relative to consensus estimates, graphed against the S&P 500 index.

There are actually two CESIs graphed below – one that measures U.S. economic data surprises and another that measures economic data surprises across the world's largest "G10" economies as a whole.

The first chart shows that the S&P 500 tends to follow the economic surprise indices – especially the U.S. one. This makes intuitive sense, because better economic data than expected typically provides investors a reason to be more bullish on the economy than before.

However, the chart also shows that two surprise indices, which usually track each other pretty closely, are starting to diverge. That divergence is typically not a good sign for the S&P 500.

The second chart, which Wilkinson says is raising the red flag for stocks, shows this a bit better. The purple line shows the CESI G10 reading subtracted from the CESI US reading. When that number falls (i.e., G10 data is seeing bigger positive surprises than US data), a pullback in the S&P 500 is usually not far behind.

Here is Wilkinson's take on what it means for the market:

What typically happens is when US domestic data starts falling into line and then falls short of expectations, investors feel little additional rationale to buy the market. Outright downbeat data often provides investors with reasons to sell. The chart shows the net reading (US less G10) rarely reverses when it starts its trend towards zero. Forays to south of the border for this net reading tend to have a negative impact on equity markets.

So to summarize, in order to avoid a negative year-end or nasty New Year surprise for equity traders, G10 data needs to start outperforming current projections faster, while the US data needs to start surprising once again. While we are not projecting a stock market rout (arguably we just had one after the election), the net reading and the magnitude of the surprise index data is raising a red flag. However, that flag could easily become lowered beyond the fiscal negotiations and the US economy pick-up the slack again.

Tomorrow is a big day for data releases – nonfarm payrolls at 8:30 AM ET, consumer confidence at 9:55 AM, and consumer credit at 3 PM. Follow the releases LIVE on Money Game >



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