Markets Shrug Off Good News

When it comes to the financial markets, often the reaction to news is more important than the news itself.  This week, I'd have to admit that much of the news was quite positive, including:

• July Existing Home Sales rose 7.2%, well above expectations of a 2.1% increase;
• The Case/Shiller Home Price Index showed a month-over-month increase in home prices;
• Consumer Confidence rose from 46.6 to 54.1;
• July Durable Goods Orders rose 4.9%, above expectations of +3%;
• New Home Sales soared 9.6% in July;
• Second quarter GDP was -1.0%, better than expectations of -1.5%;
• July Personal Income & Spending matched expectations, and June numbers were revised up;
• Dell beat earnings expectations, and Intel raised its revenue guidance for the third quarter.

The above data points add further evidence that the recession is ending and the economy should grow in the second half of this year. One would expect the market to rally strongly on news like this, yet each day this week the market had trouble holding on to initial gains. By the end of Friday's trading, stocks managed only a small weekly gain and finished about 1% off the week's high.

What does all of this mean for the markets? It could be that stocks are just consolidating the strong gains from July and August, poised to move much higher once traders return from summer vacations. Then again, it is wise to remember that the news is always best at the top, and worst at the bottom. Back in March, very few investors could envision the strong rally to come. Today, investors are tripping over themselves to buy stocks, either convinced the rally will continue or too scared to miss it if it does.

Investors chose to ignore other, rather negative, news last week. First, the Administration announced that the federal deficit over the next 10 years would be $2 trillion higher than originally forecast, to $9 trillion. Isn't it amazing how easily we say the word "trillion"? Next, the FDIC disclosed that 111 banks were added to its "endangered" list in the second quarter. Over 400 banks are now considered by the FDIC to be at high risk of insolvency. Meanwhile, the assets of the FDIC's insurance fund have declined to just over $10 billion. Finally, delinquencies and foreclosure rates continue to rise. Despite these facts, most market pundits say the credit crisis is over. We disagree, and continue to approach the equity markets with caution.