Stocks Idle in the Shade as Plant News Gets Sunnier - TheStreet

The economy's turning up. Let's sell some stocks.

The stock market's nasty reaction to a rosier-than-expected reading on manufacturing health prompted some head-scratching on Wall Street on Wednesday. The December

purchasing managers' index, based on a survey of manufacturers, came in at 48.2, up strongly from the 44.5 registered in November and well above economists' consensus expectation that it would print at 45.5. Yet stocks deteriorated after a solid start to the new year. The

Dow Jones Industrial Average

dropped below 10,000 following the report before creeping back toward break-even by the afternoon.

This despite the fact that nothing in the PMI could be construed as bearish for the economy.

"This is clearly much stronger than expected," says Credit Suisse First Boston bond market strategist Mike Cloherty. "It suggests the whole inventory-drawdown process is complete and we'll turn back to building them up again. That should help get a plus sign in front of first-quarter

GDP."

In the subindices that make up the guts of the report, what stood out for many economists was that manufacturers continued to liquidate inventories in December while new orders rose. Much of the decline in the economy has been the result of companies rapidly scaling back inventories that were far too high as demand dried up. Now, with the rise in new orders suggesting demand is improving, it appears that corporate America may have overshot on the inventory drawdown. As a result, along with raising production to meet rising demand, manufacturers will also need to restock their larders. This classic accelerator effect could give the economy a nice boost.

"This represents a turning point," says Salomon Smith Barney economist Chris Wiegand. "You've got a recipe for a return to solid growth." Though the economy clearly isn't out of the woods yet, and though consumer worries and a stumbling global economy may make the initial stages of the upturn muted, Wiegand reckons that the economy will end up growing this quarter. That's a view that has lately gathered more currency among economists, many of whom until recently agreed that growth wouldn't return until the spring.

So given the surfeit of good news, what's with the decline in stocks?

The easy answer is that this is a classic sell-the-news situation. But that's probably also the wrong answer. The economy is not an event but a process. The purchasing managers' index gives us a snapshot of how that process is unfolding; this month it suggests that growth expectations need to be taken up a notch. So the first quarter will be stronger than forecasters thought, so will the second, so will the third, and so on.

A better answer is that, even though the strength of today's report exceeded virtually all economists' expectations, the market's not content with a mere rebound. It wants a screaming economywide rally.

"While this report was good, the expectations that the market built were still too high," says Pete Boockvar, equity strategist at Miller Tabak. Investors had got far too sanguine about recovery, he says, and they lost sight of current pain. As companies begin to issue their fourth-quarter reports, investors are going to get some stern reminders that things still aren't all that great.

Jim Volk, a trader at D.A. Davidson, describes the selling in the face of the rosy economic data a little more succinctly: "Prices are too high."