Dollars and Sense: Markets remain jittery on mixed economic news

Markets jittery. We saw a lot of volatility in the markets last week. On May 8, the markets had their best day in several months. Then they dropped Monday, Tuesday, and Wednesday of last week. If you look at the end-of-day closes, you might think the markets just drifted, but there were a lot of intra-day ups and downs. Then they roared back on Thursday, with the S&P setting a new record, and the Dow getting close to records. Both indexes rose again, though only slightly, on Friday.

Uncertainty ahead. We’re seeing a lot of uncertainty in the economy and in the direction of the Fed regarding interest rates. Stock prices are already near records, so absent some solid fundamental reasons—such as stronger earnings—there’s not a lot of upside pressure. On the other hand, the rally of the past five years means a lot of investors are sitting on huge gains, so they don’t have a lot of incentive to sell, either. And the markets’ inexorable upward trend has punished investors and fund managers who predicted a correction. So a lot of people are still hanging out at the party even though they know they’ve overstayed their welcome. That means the daily news has an outsized impact. That’s a big part of what’s causing the volatility—an over-reaction to the news cycle.

A few signposts. So what has the news been for the past week? Falling oil prices pulled down energy stocks. We had something a bit unusual happen last Tuesday. The U.S. treasury sold $24 billion in bonds, and the flood of supply temporarily pushed bond yields to six-month highs. That means corporate borrowing costs are higher, and that sent a ripple effect through stock markets worldwide. The Dow dropped more than 100 points on Tuesday, but then recovered to end the day barely down. But it was a fairly exciting day, even if prices at the closing bell looked little changed. A weak retail sales report for April also created caution. Retail sales were virtually unchanged, falling short of economists’ expectations of a 0.3 percent increase. But the employment situation continued its slow but steady improvement: We also learned on Thursday that weekly jobless claims remained near 15-year lows, as applications for unemployment benefits fell 1,000, to a seasonally adjusted 264,000 last week.

Greece fires. Greece also contributed to the volatility. A debt default would destabilize Greece, potentially causing it to fall out of the eurozone. Eurozone finance ministers are reporting progress, but said more work is needed before finalizing a deal. Greece did make a major concession late in the week, saying it would privatize its largest port as part of the plan to raise capital. It’s becoming increasingly apparent to the world that Germany, in particular, is going to hang tough in the negotiations with Greece, so I do expect to see a deal, and I expect the deal to be more or less what the eurozone partners want and need to happen.

Mergers and acquisitions remain strong. Mergers and acquisitions keep on coming. We saw yet another acquisition in the energy space when Noble Energy agreed to buy Rosetta Resources for about $2.1 billion in stock. The big news for the week was Verizon’s $4.4 billion bid for AOL.

The week ahead. It will be a quiet week for economic reports, but we will get the consumer price report on Thursday. That is one of the few monthly reports that by itself has the ability to move the markets. The CPI is based on a price of a basket of goods. It is the most widely cited inflation indicator, and it is used to calculate cost of living adjustments for government programs. It’s also the basis for many private labor agreements as well. It has been criticized for overstating inflation because it does not adjust quickly enough for substitution effects. That is, when the price of something goes up, some people will stop buying it and substitute that item for something of lower price. Also the basket of goods does not reflect price changes in new technology goods, which are often declining in price. Still it remains the benchmark inflation index, and I and lots of analysts will be paying attention when the number comes out this week.

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