This week, the pessimism of the prior two weeks gave way to a look at economic data that don't look unhealthy, and don't change the odds of another interest rate increase next month.
For the week:
S&P 500 +1.0%
S&P Midcap 400 +0.4%
S&P Smallcap 600 +0.8%
Monday and Tuesday brought no economic news and the market floundered in the vacuum, wringing its hands over the prior week's sea of red ink. The Nasdaq fell 1.6% to a six-month low. Technology bore the brunt of the selling. I took advantage of the weakness to pick up shares of eBay on Monday at $29.
On Wednesday, we finally got some fresh economic data. April durable goods new orders dropped 4.8%, more than expected. The slower pace got a few people thinking that the Fed might not raise rates in June.
Then, April new home sales came in at 1.2 million, a surprisingly strong 4.9% gain. That's the highest this year. A strong housing market over the past few years has boosted consumer spending with mortgage refinancing and home equity cash. Its inevitable slowdown has been expected to curtail consumer spending and, therefore, hobble the economy. So far, though, the housing market shows no weariness. Consumers can keep their shopping lists and gas tanks full, and that's good for the economy.
On Thursday morning, the mood got even better at 8:30 when first quarter GDP was revised upward from its initial 4.8% annual growth rate to an even stronger 5.3%.
Now, wait a minute, you say. I thought we wanted to see a slowing economy so the Fed can stop raising interest rates.
You're right. What's missing in the above facts is that economists had expected a revision up to 5.8%. Coming in at 5.3% was the economy’s version of a bowl of porridge for Goldilocks: it wasn't too hot and it wasn't too cold, it was just right. It grew faster than we thought, but not so fast that extreme braking is required to keep it under control. Growth without inflation is about as good as it gets in economic circles, and Thursday morning delivered it.
The market rose, led by technology. A multi-year advertising and payment partnership between eBay and Yahoo, and an agreement between Dell and Google that will put Google search software on Dell computers, brought more buyers onto the scene. Shares of eBay rose 12%. Among the big indices, the Nasdaq rose the most at 1.3% for the day.
Nothing follows good economic news like more good economic news, and we got it on Friday morning. The core-PCE deflator, an inflation gauge favored by the Fed, rose 0.2%. That's less than economists feared it would be, but actually not very low. The Fed wants a year-over-year increase between 1.75% and 2%, and this latest installment puts it at 2.1%, up from 2.0% in March. The market's positive reaction shows how much the mood changed in a week. Had the report happened a week earlier, the focus would have been on the above 2% angle rather than the less than feared angle.
This may be the first time you've seen the term core-PCE deflator. PCE stands for personal consumption expenditures, and is the amount that people spend on goods and services. A deflator is a statistical tool that changes current dollars into inflation-adjusted dollars so we can easily compare prices over different time periods.
May has provided a textbook lesson in market moods. In the last four weeks, we went from ebullient to depressed to cheerful. On May 10, the Fed raised rates and said that it would watch incoming data before deciding its future actions. Because that language didn't say the Fed was leaning toward ending rate increases, the market got worried...and started obsessing over incoming data.
But so far, those data have been mixed:
- The U.S. trade deficit narrowed to $62 billion, lower than the expected $67 billion. (That was good for the economy, but meant that GDP would be higher, which could be inflationary.)
- The University of Michigan consumer-sentiment fell to 79 in May from 87 in April, the lowest since October's score of 74. (People buying less is good for keeping inflation at bay, but bad for economic health.)
- The core consumer price index (CPI) increase for April came in at +0.3%, 0.1% higher than expected. (That showed an inflation risk.)
- First quarter GDP was revised upward from its initial 4.8% annual growth rate to 5.3%, lower than the 5.8% feared. (A higher GDP could be inflationary, but being lower than feared was a bright spot.)
- The core-PCE deflator rose 0.2%. (That's less than economists feared, but puts the year-over-year increase at 2.1%, higher than the Fed's 1.75% to 2% comfort zone.)
After digesting that mixed bag, Fed funds rate futures hardly budged. They still expect another 0.25% rate increase.
What changed on Wall Street was the mood, not the facts. Remember this well, for it's the persistent theme of markets. Changing moods change prices, and provide intelligent investors with opportunities. I’m sticking with my forecast for strength in early summer, trouble in August/September, and a rally at the end of the year.