Will The Real Economy Please Stand Up?

Are economic reports finally indicating an acceleration in the economic recovery - or not?

Markets need to know. Investors need to know. Most importantly, the Fed needs to know.

The prognosis changes from month to month, even week to week, and this week even day to day, as expectations for Fed action move from taper on, to taper off, to taper on and back again.

This week several reports indicate the economy is indeed recovering impressively, reversing last week’s mostly dismal reports. For the first four days, the stronger reports had the Dow down 1.7%. But the additional positive reports Friday had the market up strongly, the Dow up 1.2%.

This week’s positive reports include that GDP growth in the 3rd quarter was revised up from the initial report of 2.8% growth to 3.6% growth. But it wasn’t an all clear. Analysts noted the unexpected jump in growth was entirely due to a build-up of unsold inventories by businesses, which will likely be reversed in the 4th quarter. It was also reported that the ISM Manufacturing Index edged up to 57.3 in November from 56.4 in October. But the ISM non-mfg Index, which covers the services sector, fell from 55.4 in October to 53.9 in November. New home sales jumped 25.4% in October, but existing home sales fell 3.2%.

On Friday it was reported that 203,000 new jobs were created in November, much better than the forecast for 180,000, while the unemployment rate fell from 7.3% in October to 7.0% in November. And the University of Michigan/Thomson Reuters preliminary calculation of its Consumer Confidence Index showed consumer confidence jumped to 82.5 in early December from 75.1 in November, much better than the consensus forecast for a rise to only 76.5.

The positive reports this week certainly seem to raise the odds that the Fed will begin tapering back its QE stimulus, perhaps as soon as its next FOMC meeting in two weeks.

Except that continuing negative reports raise questions about whether improving jobs and consumer confidence are enough to indicate the recovery is back on track.

For instance, reports related to the important housing industry indicate a possible downside reversal in its recovery.

Pending Home Sales have fallen for five straight months. Residential housing construction fell 0.6% in October. The Mortgage Bankers Association reported that mortgage applications fell a significant 12.8% last week, the fifth straight week of declines. The reasons are not likely to go away anytime soon. Home prices are up 12% over the last 12 months. And mortgage rates have risen 29% over the last seven months (to 4.46% this week). The increase in mortgage rates alone probably translates into 20 to 25% higher monthly mortgage payments for would-be home-buyers.

And in the general economy it was reported that Durable Goods Orders fell 2.0% in October, while the separate report on Factory Orders showed they fell 0.9%. The Fed’s own National Business Activity Index, comprised of 85 economic conditions and indicators chosen by the Fed as the most important, plunged from +18 in September to -18 in October. Yet in the Fed’s ‘beige book’ report this week the Fed said the economy continues to grow at a “modest to moderate” pace, the same language it has been using all year.

Markets and investors are understandably confused.

The stock market was up last week in reaction to mostly negative economic reports, the economy apparently not as important to investors as the hope provided by the negative reports that the Fed will not begin tapering soon.

Then, with the strong reports this week, the market was down sharply the first four days of the week, the Dow losing 266 points, apparently on fears that the strong reports meant the Fed will begin to taper soon.

However, with the additional positive jobs report on Friday, raising the odds higher that the Fed will begin tapering soon, the market rallied strongly, the Dow up 170 points by mid-day.

The confused reactions could be seen not only in stocks, but also in the reaction of bonds, gold, and the dollar, which do not usually move in the same direction, but which were also all up in reaction to the jobs report.

Apparently the increased odds that the Fed will begin removing its QE supports from under the economy and markets had some investors moving into traditional safe havens of gold and bonds. Meanwhile, others who were selling since Monday on strong economic reports that raised concerns the Fed would begin to taper, reversed their assessments on Friday, pouring back into stocks, perhaps now convinced the economy is strong enough to no longer need the Fed’s QE supports.

Hopefully, the Fed is not still as confused and undecided as markets. Its similar confusion has been indicated by its taper on, taper off, taper on guidance since May.

My own opinion is that the mixed reports and conditions will leave the Fed still undecided.

Meanwhile, as long-time readers know, I have always referred to the monthly jobs report as the ‘Big One’, because it most often comes in with a surprise in one direction or the other that results in a big kneejerk reaction, and a triple-digit one to three day move by the Dow. The other side of the pattern is that whatever is the direction of the initial reaction is usually reversed in subsequent days as the market returns to whatever was its focus prior to the report.

So we shall see what happens this time.

Meanwhile, my Seasonal Timing Strategy remains in its favorable season and is 100% invested, while my non-seasonal Market-Timing Strategy remains on a buy signal. But it is only 40% invested, as I still expect a short-term correction of 5 to 8%.

This bounce back on the jobs report, coming before the overbought technical condition was alleviated, and before the extreme bullish investor sentiment was cooled off at all, does not disabuse me of that expectation, at least not yet.

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Sy is president of StreetSmartReport.com and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.