When bad news is good . . .

If there was any doubt that the stock market remained dependent on the Federal Reserve, it was proven twice again. Last week, Chairman Ben Bernanke said the central bank could begin pulling back on stimulus measures, commonly referred to as quantitative easing, if officials see evidence of “sustained” economic growth. Those comments along with a flurry of good economic reports knocked the S&P 500 down by 1.1% as traders worried that the Fed might soon release the market to swim on its own.

Yesterday, the government revised downward by .1% their already weak estimate (2.5% prior) of first quarter US economic growth, known as GDP. On that news, the S&P gained as much as .5% during the day on that bad, err good news. As the thinking goes, the stock market party will continue as long as the Fed keeps the bar open, but a looming ‘last call’ is dampening spirits.

As reported by Bloomberg, during Mr. Bernanke’s prepared comments to Congress, markets rallied when he said that a premature withdrawal of quantitative easing would put the economic recovery at risk. They promptly reversed course when he said the central bank could “step down” the pace of asset purchases in the next few meetings if the labor market continues to improve and “we have confidence that that is going to be sustained.”

The summer is shaping up to be a jittery one for investors who search for favorable currents in which to swim. In many ways today’s economic conditions mirror those that preceded the last two summers of declines in economic and market conditions. This time though, bad economic news is good market news as it ensures continued Fed support.

The Fed has said they would maintain stimulus until the jobless rate falls to 6.5%. It now stands at 7.5% and yesterday’s jobless claims failed to support the recent positive trend in jobs. According to Econoday, claims rose by 10,000 to a 354,000 level, a sizable 14,000 above consensus estimates. The trend for initial claims, after having improved from late March, now looks flat over the last two months.

The engine of the US economy is the consumer and the engine is losing power. The government reported today that the month of April saw both income and spending were flat, following increases of 0.3% and 0.2%, respectively in March. The report also showed that inflation was quite soft.

Regarding inflation, Richard Yamarone of Bloomberg says “the Conference Board’s Index of Coincidental Indicators increased 0.1% in April, while the Chicago Fed’s National Activity Index (a manufacturing gauge) fell to minus 0.53 in April, down from a minus 0.23 reading in March. These indicators suggest the economy will probably continue trending lower in coming months possibly tipping the current disinflationary environment into deflation.”


The engine of the stock market is corporate profits and now that engine may be losing power. The Bureau of  Economic Analysis reported yesterday that first quarter profits slipped to $1.738 trillion annualized, down from $1.774 trillion in the fourth quarter. Profits in the first quarter declined an annualized 7.9% after gaining 7.5% in the fourth quarter. Corporate profits on a year-on-year basis increased 4.0%, compared to 13.3% in the fourth quarter.

These reports clearly do not provide “evidence of sufficiently strong and sustained growth” and if the negative trends continue one has to wonder how much more bad news stock investors will consider good. This summer might be another hazardous season for investors who like to swim the currents. Conditions seem quite favorable for strong cross and rip currents to ruin their day. If you swim without supervision, please swim with caution.