Market Challenged by Macro Concerns

Last week we declared that the rally was facing a challenge, as reflected in Wednesday's market action.

Given all of the fundamental and macro events which have occurred since our (mostly) technical assessment a week ago, perhaps it's time to take a closer look at what is now ailing the markets.

The Fed

The Federal Open Market Committee met Tuesday to discuss its inflation expectations and the gradual end of its accommodative policy. Since what it did -- a 25-basis-point rake hike was essentially fait accompli -- mattered less than what it said, it is important to read the tea leaves correctly.

The FOMC's comments reflect the somewhat contradictory nature of the economic expansion. It re-emphasized the gradual removal of its accommodative monetary stance to a more neutral policy, while at the same time it stated that "monetary policy remains accommodative."

The Fed stated that the recent "soft patch" is showing signs of abating, though its language -- "output growth appears to have regained some traction" -- hardly suggests robust expansion. Further, the statement "robust underlying growth in productivity is providing ongoing support to economic activity" is contradicted by the slowdown in productivity gains and the weakening in GDP. Even the Fed's inflation statement is self-contradictory: "Despite the rise in energy prices, inflation and inflation expectations have eased in recent months."

Hey FOMC, thanks for clearing things up.

I believe that the Fed's statements about both growth and inflation are leading examples of the "clap louder" school of economic cheering. The central bank asserts that inflation is benign, but in order to keep it that way, it must move towards a neutral policy. As we shall see, inflation is alive and well and more malignant than benign. As far as growth is concerned, I believe the Fed's enthusiasm is misplaced.

Wrong on Inflation and Growth

In each of these instances, I fear the Fed got it wrong. Let's look at inflation first: Although the fed funds rate is now higher than core inflation (as measured by the CPI or PCE deflator), Alan Greenspan's favorite inflation gauges woefully underestimate real-world price pressures. That point was made clear by several household names in the consumer non-durable sector. General Mills (GIS - commentary - Cramer's Take), Coca Cola (KO - commentary - Cramer's Take), Colgate Palmolive (UL - commentary - Cramer's Take), and Unilever (UL - commentary - Cramer's Take) each preannounced disappointing earnings, citing increased prices of raw materials, including sugar and cardboard, along with transportation costs.

---

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].