As you know, there is A LOT of optimism priced into the stock market right now. But with this “economic recovery” starting to sputter, and companies racing to adjust their earnings expectations DOWN, what will happen if a string of earnings disappointments comes in?
Being Street Smart
Will the Fed Push Its Magic Button Again?
June 3, 2011
It was another week of shockingly negative economic reports, which you might think has Wall Street economists worried that the economy is running into something more than just a brief soft patch (their popular term of recent weeks).
But they mostly remain convinced that the problem is only temporary, that the economic reports are coming in worse than their forecasts only because they under-estimated the effect the surge in energy and commodity prices would have on consumer spending, and the effect the Japanese earthquake would have on auto and technology production.
And they say those effects are only temporary.
Let’s hope they’re right, because the additional reports this week were awful.
They included that home prices are still declining; that Pending Home Sales fell 11.6% in April to a 7-month low; that Consumer Confidence unexpectedly fell from 66 in April to 60.8 in May; that the ISM Mfg Index plunged to 56.6 in May from 67.6 in April; that Factory Orders fell 1.2%; that auto sales fell more than forecasts.
The reports ended for the week with Friday’s report that only 54,000 jobs were created in May versus 232,000 in April, and compared to the consensus forecast that 175,000 jobs would be created. And the unemployment rate rose to 9.1% in May, from 9.0% in April, versus forecasts that it would decline to 8.9%.
This week’s reports came on top of four weeks of similarly dismal reports, including that the Conference Board’s Leading Economic Indicators dropped into negative territory for the first time in 9 months, and that Durable Goods Orders experienced their largest decline since last August. New home starts and permits for futures starts plunged more than forecasts, and existing home sales unexpectedly plunged, now down 12.9% year-to-date.
However, not only is Wall Street not overly disturbed by the reports, but investors are not all that concerned either.
In spite of five straight weeks of decline, the Dow is only 4.7% below its peak at the end of April, and it’s still up 5.4% for the year so far. And, what decline there has been was on low volume, no signs of aggressive selling.
One theme I keep hearing from bullish investors is that the Federal Reserve will not allow economic growth to slow to any degree (beyond a brief soft patch), without stepping in with another round of stimulus. Nor will it allow the stock market to decline to any degree.
After all, they remind me, Fed Chairman Bernanke virtually guaranteed that in the Fed’s statement after its last FOMC meeting, in which it said, “The Committee will continue to monitor the economic outlook and financial developments, and will employ its policy tools as necessary to support the economic recovery.”
Meanwhile, as I wrote in early April, the similarities to a year ago are spooky. Among the long list of similarities I noted then, were that a year ago government stimulus programs were also coming to end, the economy was already showing serious signs of slowing, the stock market looked to be overbought, and investor sentiment was unusually confident and bullish. The next event a year ago was that the market topped out at the end of April into a correction, and that has now potentially become another similarity of this year.
So will the rest of the events of last year also repeat this year?
Last year, the economy continued to weaken, and the stock market remained in a correction until mid-July, during which the S&P 500 lost 16% of its value.
And then the Fed seemed to panic and stepped in with a promise of another round of quantitative easing, which was dubbed QE2. The economy picked up again, and the stock market halted its decline, recovered its losses, and went on to the highs reached at the end of April this year.
The big question is, if the economy continues to slow this year, and the stock market continues to decline, will the Fed push the magic button again?
Chairman Bernanke received considerable criticism at home and globally for his QE2 decision last fall. It also doesn’t seem to have worked all that well. The flood of additional dollars into the financial system pumped up the stock market and commodity prices, creating inflation, but its effect on the economy was apparently only temporary.
And this year, Congress would probably object mightily to another round of stimulus, given its new determination to cut government costs in efforts to tackle the record budget deficits.
So, unless the economy really nose-dives, I suspect the Fed will allow the market system to function normally this time around, allowing economic growth to slow if that is its inclination, and the stock market to adjust to that, without government interference.
But we shall see. So far the similarities to events a year ago continue to click into place.