Remember Bizarro World? That was the comic book land where bad was good, lies were truth, and ugly was beautiful. At first glance, it appeared we were spending some time in Bizarro Market last week, with traders' universally negative reaction to the release of a handful of positive economic indicators that pointed to a healthier 2007. The reason, of course, is the widespread assumption that the Federal Reserve will look at the numbers and either raise interest rates -- or at the very least, refuse to cut them -- as a hedge against inflation. There's a lot wrong with that thinking. To begin with, one set of indicators, or even two, is not enough evidence for the Fed to act. Indeed, a Fed vice president issued a warning on Friday against jumping to conclusions based on preliminary data. But even more wrongheaded is the negative reaction to the news that sales of previously owned homes rose in November for the second straight month and that new home sales turned positive as well. These two data points, plus indications that mortgage activity is slowly strengthening, shows that the dangerous slump in housing may well have bottomed out. And given the overwhelming importance of housing and homeownership to the overall economy, any news that the so-called bubble is not going to collapse should be cause for rejoicing. Worrying that more housing sales will spook the Fed into raising rates is, well, bizarre.
(Yes, prices are down a bit, and there are inventory issues to contend with, all of which argue for getting more data before drawing a firm conclusion.) There are, in fact, a number of reasons to be cautiously optimistic, says Lakshman Achuthan, managing director of the Economic Cycle Research Institute. In his latest report, Achuthan, who works with a large basket of leading economic indicators, says that his Weekly Leading Index has risen steadily for four straight months. The implication? "Recession is not a serious concern; and remember, bear markets are almost always associated with recessions," he said in an interview. Components of the WLI include money supply, housing activity, prices of industrial materials, bond market measures, stock prices and employment data. Like the National Association of Realtors, ECRI's data supports a strengthening in the housing market -- its index of leading home prices has been up for two months. However, "I'm hesitant to say we are out of the woods. I'd need three or four months to say the market has really turned," Achuthan. But measures of the strength of service industries meet the four-month test, and to some extent balance the weakness in manufacturing that most economists have noted. Second-guessing the Fed is tricky, of course, but Achuthan believes that the available data is not definitive enough to force a major move on rates. "
The Fed is are going to stay on hold longer than you think," he says. The board acts when it fears recession, but for now that worry is probably not on the front burner.
Similarly, ECRI's future inflation gauge is edging down, an indication that the Fed won't feel compelled to take action on that front by boosting rates. Other recently released indicators pointing to a stronger 2007 include the Conference Board's index of consumer confidence, rising to its highest level since April, and a report from the National Association of Purchasing Management showing an increase in business activity in the Midwest. Meanwhile, the December Economic Letter from the Reserve Bank of Dallas argues against making sweeping conclusions on thin economic data. "Many early economic statistical releases are inaccurate," warns Evan F. Koenig, vice president and senior economist at the Federal Reserve. "Scores of analysts use the government's initial estimates in their forecasts, which can lead to trouble." Koenig notes that many government economic studies are based on surveys that are refined and updated as new responses are tallied and old ones corrected. "Seriously misleading conclusions and subpar forecasting results are likely when analysts and policymakers treat heavily revised and first-release data as if they are interchangeable," Koenig says. And that makes it even more imperative for investors to take a deep breath before reacting to the latest scary headline about the economy.