Markets might be turning
Flat. That's how the Commerce Department described July industrial production at the nation's plants, mines and utilities in a report earlier this month.
The next day, it indicated new home construction in July had risen only slightly. These announcements followed bearish financial forecasts by several key corporations that seem to confirm dismal views about the economic recovery.
Stock prices depend on earnings growth, which in turn, rely on economic strength. A flat economy threatens corporate earnings and provides support for the Federal Reserve to continue its monthly bond purchases to spur growth.
Reinforcing the adverse economic data were a bunch of disappointing earnings reports and warnings. Bellwether companies, such as retailer Wal-Mart and tech favorite Cisco, lowered their sales and earnings guidance for the next quarter.
The housing market has been one of the strongest performers this year, but the recent news is becoming disappointing. Mortgage applications have been declining, according to Mortgage Bankers Association, apparently because of rising interest rates.
The Commerce Department added to this mix of depressing economic and housing market news by reporting Friday that new-home sales dropped 13.4 percent to a seasonally adjusted annual rate of 394,000. That's the lowest pace in nine months.
This news tended to puncture what had been an increasingly bullish sentiment that a housing recovery was under way. Housing construction is one of the most important “multiplier” and labor-intensive industries, stimulating activity and employment in many associated industries. News of a housing downturn reinforced the view that despite its $85 billion in monthly bond purchases and near-zero interest rates, America may be following the European Union and other economies into recession.
The result is an increasingly bearish outlook for equities. The Dow Jones industrial average has retreated from its high on Aug. 2 and is down 3.2 percent for the month as investors ponder when the Fed will taper its bond purchases aimed at holding down interest rates.
The possibility of higher interest rates would only boost negative sentiment. The Fed minutes last week did not give any clear indications when policymakers would end their bond purchases. But investors may be concluding that the huge Fed-inspired stock market subsidy has run its course and now is a good time to cash out.
Adding to the confusion is increasing uncertainty over the Fed's new leadership and future policy. Chairman Ben Bernanke is expected to step down when his second term ends in January. Fed Vice Chair Janet Yellen and former Treasury Secretary Larry Summers are jockeying for the job.
Nevertheless, continuing uncertainty over the timing and how quickly the Fed will wind down its bond purchases remains disruptive to financial markets and causes volatility.
Should interest rates continue to rise as they did last week, billions of dollars may flood out of bonds into equities, boosting prices temporarily. But this would be pure speculation.
Conservative investors may be inclined to take large profits from the Fed-induced bull markets in both bonds and equities and move to cash or precious metals.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.
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