Taking the Bad with the Good

Yesterday’s new home sales report surprised everyone as sales surged 16% in April, the biggest jump in 14 years. The news sent stocks surging higher with the Dow up 100 points before traders took a broader, dimmer view sending the Dow down 85 points, the S&P down 1% (short of its record yet again), and the NASDAQ down 1.5%. The S&P 500 and the Dow may end their seven-week gain streak with this week’s decline of 1% so far. The bond market has retreated for two weeks as yields have marched steadily higher.

On Wednesday Mr. Greenspan raised worries as he made another prediction that rattled investors. The former Fed Chairman suggested thatChina’s stock market is overvalued and was overdue for a major correction. The comments were likely still on the minds of traders yesterday as Asian stocks were among the hardest hit. The two-day summit inChinayielded agreement to open its financial-services market to foreign firms and on expanding aviation services. Currency reform, however did not gain much ground. 

While most attention has been focused on the drag of housing and energy on the slowing economy, BusinessWeek suggests that the decline has bottomed. They point to the latest reports from the manufacturing sector suggesting that it is sustaining growth in ways the Fed has said would. The Fed, in ignoring calls for a reduction in interest rates, has suggested housing wouldn’t bring down the rest of the economy with it, and that business investment would help be a counterbalance for any slip in consumer spending, the biggest source of economic growth. While “the manufacture of goods represents only a little more than a third of the overall economy, as measured by real gross domestic product,” BusinessWeek notes, “the industrial sector still contributes greatly to short-term shifts in the economy’s growth rate.”

Vernon Smith, a Nobel laureate economist, was featured in Wednesday’s WSJ for his highly optimistic views on stocks and the longevity of this bull market. Fritz Meyer, who develops investment strategy for AIM Investments, a $149 billion money-management group in Houston, sees stock gains stretching as far as the eye can see. The Journal says that these extreme optimists believe that global economic strength will keep shares rising for much longer than has been common in previous eras. Not only China and India, but also Japan, Western Europe, Latin America and other parts of Asia are feeding on one another. And the huge pools of private capital in the world snapping up public companies at an historic pace continue to provide significant short-term momentum in the market.

Warnings of an overheated Chinese economy, troubled oil supply lines, creeping inflation threat, Iraq, and Iran help keep a lid on “irrational exuberance” or excessive speculation that might otherwise define today’s market. But while stock prices have risen considerably, valuations are not out of line with earnings or interest rates. In other words, the economic facts support stock prices, but the sway of emotions cannot be predicted. A comment by Greenspan or China, or Vladamir Putin can change market moods in a flash. But for now, emotions seem to be equally balanced between bad and good.