Is Good Economic News Bad for Stocks?

Zacks

Monday, June 3, 2013

Pre-open sentiment is pointing towards a positive start to today’s trading session despite another day of heavy losses in Japan and mixed trends elsewhere. But this may not hold up later in the session as market participants respond to incoming data, particularly the May manufacturing ISM report. Expectations are for a modest uptick from the prior-month’s level, but positive data may not be market friendly in the current environment of ‘Taper’ talk.

Nobody doubts that the Fed will need to curtail the pace of its monthly bond purchases at some stage in the coming months. The uncertainty is about the timing of that move – is it coming in this month’s FOMC meeting, later this year or early next year? This week’s economic data, particularly Friday’s jobs report, will help clarify matters quite a bit. I have been of the view that a strong jobs report on Friday will increase the odds of the ‘Taper’ announcement in this month’s Fed meeting.

The announcement, whenever it comes, would not mean an end to the Fed’s easy-money policy, but it would signal the beginning of the end. The ‘Tapper’ would likely be followed by an end to all bond purchases at some stage and the eventual unwind of the Fed’s balance sheet. A lot is still unclear how all of this unfold, but few doubt that this will be a long and drawn out process, spanning many years.

The start of such monetary policy ‘normalization’ is a net positive for the economy as it would signal the central bank’s confidence in the recovery. But it will nevertheless be dislocating and disruptive for the stock market. Rock bottom interest rates as a result of the Fed’s easy-money policy have been a key driver of the market’s gains. If nothing else, such a ‘normalization’ in interest rates will cause a shift in market leadership from defensive to more cyclical sectors. The recent loss of momentum for traditional dividend paying stocks and pronounced gains for the banking sector are signs of such shift.

Sheraz Mian
Director of Research

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