Is The Fed Overdoing It?

The Dow and S&P 500 gapped up at the open this morning, but quickly gave way. At the moment, they’re down roughly .5%. The culprit: positive economic data (see below). Looking under the hood, defensive sectors like consumer staples and utilities are taking a beating, whereas growthier sectors like tech and materials are barely lower. The VIX fear gauge just climbed over 33, indicating more volatility over the next 30 days. Commodities are getting a little support from a weaker dollar today, but the overall trend still favors a strong dollar & weak commodities. Copper is down 25% year-to-date, and oil is down about 13% so far this month. Global recession fears are also to blame. Unlike stocks, the bond market is acting like you would expect given decent economic news—Treasuries falling in price, riskier corporates rallying.

The Commerce Department’s index for corporate capital spending surged more than expected last month. New orders for capital goods excluding aircraft and defense equipment jumped 1.3% from the prior month and nearly 10% from year-ago levels. In addition, July numbers were revised upward. Despite significantly higher borrowing costs and fears of a coming recession, businesses continued to invest in computers, electrical & communications equipment, machinery, and primary metals. But while good news for economic growth, investors clearly aren’t convinced this is helpful. First, the Federal Reserve is bent on slowing the economy in order to contain inflation. So evidence of strength may encourage Fed officials to push ahead with “restrictive” monetary policy. Second, this report stands in contrast to other recent data suggesting a slowdown in global manufacturing.

Following the good-news-is-bad-news theme, the Conference Board’s closely watched gauge of consumer confidence improved unexpectedly for the second straight month. The survey reflects continued strength in the job market, rising wages and falling gasoline prices. Consumers’ six-month outlook rose to the highest level since February just as the survey’s expected inflation rate over the next 12 months slowed to 6%, the lowest since January. Again, this would normally be greeted as good news because confidence typically begets spending. But the job market is squarely in the Fed’s crosshairs, the goal being to raise the unemployment rate to 4.4% by year-end and curtail wage growth.

Home prices are beginning to fall under the weight of rising mortgage rates and awful affordability levels. The FHFA Home Price Index fell .6% in July whereas economists were looking for no change. On a year-over-year basis the index is still up 14% but the chart has clearly rolled over. The Case-Shiller Home Price Index confirms the trend. Back in the spring prices were soaring 20% y/y but that rate has fallen to 15.8% and is poised to fall further. At the same time, we can’t get too negative. New home sales surged nearly 30% in August from the prior month. Yes, homebuilders are discounting. But demand is a reality backstopped by the fact that we underbuilt home for a decade after the Great Financial Crisis in 2008. The way I see it, we are normalizing rather than crashing.

My bottom line is that despite all the fear—and atrocious investor sentiment—the economy isn’t yet falling apart. If the Fed would stop tough-talking us every waking moment, the stock market might begin to appreciate that fact.