Taking the Good Over the Bad

SAN FRANCISCO -- Perhaps investors are starting to think Schaeffer's Investment Research was right when it commented Monday that the market is developing a tolerance to the Fed's rate-cutting vaccine. For the second-consecutive session, stocks reacted today as if they're not so anxious to see more interest-rate cuts from the Fed anytime soon.

Maybe it's just a coincidence -- clearly there were other factors on both trading days, today including better-than-expected earnings from Disney (DIS Quote) and Chevron (CHV Quote).

But bear with me, because it could just possibly be that equity investors are realizing that what's good for the economy is good for the stock market. It may seem counterintuitive to newer investors, but the stock market has more recently embraced negative economic news because it increased the likelihood of more aggressive Fed easing. But after 200 basis points of easing thus far in 2001 and little evidence of improvement in either the stock market or the economy, some investors are starting to appreciate healthy economic news -- even if (especially?) it bodes poorly for future Fed rate cuts.

Yesterday, equities tumbled despite a weaker-than-expected Consumer Confidence report for April, which might encourage additional rate cuts. Today, the Dow Jones Industrial Average and S&P 500 each gained 1.6%, and the Nasdaq Composite Index climbed 2.1% following some upbeat economic reports.

First, durable goods orders rose 3% in March, vs. an expected 0.6% gain, the Commerce Department reported. Second, Commerce also reported that new home sales rose 4.2% in March to a record annualized rate of 1.02 million. Third, the National Association of Realtors reported that sales of previously owned homes rose 4.8% to an annualized rate of 5.44 million in March -- better than the expected 5.1 million and the second-highest ever.

"There is a pulse," Kenneth Mayland, president of ClearView Economics in Pepper Pike, Ohio, declared in a report focused on the durable goods data. "This patient -- the manufacturing sector -- may be in intensive care, but it has not, and will not, flat-line."

Reflecting the positive implications of the economic reports, as well as the stock market's rally, Treasury bonds weakened. The price of the benchmark 10-year bond fell 15/32 to 97 31/32, its yield rising to 5.27%.

But, as is often the case, there was plenty of debate on the real significance of the economic data.

Regarding the housing statistics, economic doomsayers note mortgage rates lately have been creeping higher. Thus, a big, pesky counterbalance to the recession scenario provided by the strong housing market might wane, they claim -- with some justification. Conversely, those with a more-optimistic bent noted yesterday's weak consumer confidence reflected survey results taken prior to the Fed's latest rate cut. (To date, rate cuts still are believed to enhance consumer confidence, but stay tuned.)

The durable goods report experienced the heaviest parsing. Many observers noted orders fell 1.8% when a huge increase in transportation orders were excluded.

"Despite the few positives, the bulk of the details in the report are not favorable toward the economy, as most industries saw a decline in orders," commented Tony Crescenzi, CEO of BondTalk.com. Industrial machine orders -- which include computers, computer storage and peripherals -- fell 0.7%, while electronic equipment dropped 5.3%, reversing a 6.7% gain in February.

But Crescenzi, who's also chief bond market strategist at Miller Tabak, suggested it's not surprising that overall durable goods orders have yet to pick up.

"It takes many months of sustained improvement in final demand before orders generally increase," he wrote. "But the rapidity of the inventory adjustment, combined with a surge in automobile production, secular forces, strong housing conditions, massive mortgage refinancing activity, and the lagged effects of the Fed's rate cuts should lift the durable goods sector" in the months ahead.

In other words: The seeds of economic recovery have been sown, which the bond market is forecasting, and perhaps stocks as well. But the beauty of statistics -- particularly the economic variety -- is that they always offer an opportunity for someone to argue the other side.

Speaking of...

...The other side -- of the pond that is -- the European Central Bank is scheduled to meet tomorrow. After repeated failures to cut rates in recent weeks and little public indication that a change of heart is afoot, few are expecting the ECB to ease tomorrow.

Let's hope the Europeans have learned a lesson from Alan Greenspan, whose strategy prior to April 18 was to dampen expectations for an intermeeting ease in the hope of getting more bang for his rate-cutting buck. As mentioned here previously, the outlook for the U.S. economy and earnings of U.S. multinationals would be enhanced if the ECB gets in a rate-cutting gear.

Today, the International Monetary Fund cut its estimate for 2001 economic growth in the euro zone to 2.4% from 3.4%.

"Sure, monetary policy globally is being eased, but it cannot really be described as a synchronized ease while the ECB drags its feet," David Bowers, world markets investment strategist at Merrill Lynch, commented last week (he was unavailable today). The "latest move by the Fed, coupled with [recent] reluctance by the ECB to ease policy, highlights once again the major and growing divergence in monetary policy stance between Europe and U.S."

The dichotomy supports Merrill's preference for U.S. equities over European, Bowers said. It also should give pause to those still complaining the Fed isn't being aggressive enough.

The central bank grass is greener here.

The Sentiment Please

Investors' Intelligence reported that newsletter writers who are bullish fell to 43.9% last week from 44.7% the prior week. Bearish sentiment also dropped to 41.8%, from 42.5%, while those expecting a correction rose to 14.3% from 12.8%.

Given the survey was conduced after three weeks of rallying and the Fed's April 18 intermeeting cut, the fall in bullishness is surprising. It is also a positive sign for those who believe in the contrarian powers of such data.

On the other hand (and to bring things full circle), the folks at Schaeffer's today noted Time's financial editor Daniel Kadlec essentially called a market bottom in the magazine's latest issue. This is significant because it comes only about a month after the national weekly's bearish cover, one of several that got some talking about "magazine indicators." Elsewhere, Schaeffer's points out the cover of the May issue of SmartMoney asks readers: "Are You Ready for a Rebound?"

It should be noted that Schaeffer's adopted a defensive stance back on March 6, so this reverse magazine indicator supports their view. But it bears repeating as a counterweight to the sentiment figures.

As mentioned earlier, there are two sides to every story.