Even smallest of news makes traders jump

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Wall Street's advance Monday brought major market indexes closer to where they closed June 18, the day before Federal Reserve chairman Ben Bernanke's comments on a possible timeline for ending the central bank's easy money policy unleashed a torrent of selling.

Mr. Bernanke's tentative timeline for gradually ending quantitative easing was premised on the Fed's forecast that the U.S. economy will grow 2.3 to 2.8 percent this year. That view was called into question last week when the U.S. Commerce Department said the economy grew at only a 1.8 percent clip in the first quarter, not the 2.5 percent increase in the gross domestic product the agency originally reported.

As the gloomier version of what the economy looked like three months ago came out, Fed members were soothing markets, saying tapering depends on how the economy performs. That's basically what Mr. Bernanke said in his June 19 press conference.

The result: The market has turned on a dime.

The episode shows what can happen when Fed pronouncements, short-term traders and imperfect, often conflicting, economic data collide.

"What matters in the market isn't what I thought was true. It's what everybody else in the market thought was true," said Steven Kyle, a former bond trader who teaches economics at Cornell University.

Mr. Kyle said bond traders took Mr. Bernanke's statement that the Fed could begin tapering its $85 billion monthly purchases of federal securities later this year as a sign that interest rates are header higher and bond prices are headed lower. Sellers were motivated not by the Fed's optimistic long-term outlook, but rather by their short-term prospects.

"They aren't in this for the long run. They get their profits measured weekly or quarterly," Mr. Kyle said. "It may be that [the economy] comes right eventually, but that doesn't matter to them. They care about now, right now."

For those with a longer point of view, the revision in the first quarter gross domestic product further documents a recovery struggling to gain its footing. Daily uncertainty over what the data is saying about the economy's prospects is compounded when the market misinterprets government reports.

"It's amazing how much emphasis people put on minor changes," said Daniel Meckstroth, chief economist for the Manufacturers Alliance/MAPI, a public policy and research group. "Revisions are just part of life."

Federal agencies routinely update reports on unemployment, trade and other measures of the economy. In the case of GDP, the Commerce Department serves up three reports: the first or "flash" report based on preliminary data and estimates; a first revision based on more data and estimates; and a second revision based on even more complete information. Some of the reports can change dramatically from week to week, or month to month.

"Most sensible analysts who look at these numbers on a regular basis understand that that's what it is," said IHS chief economist Nariman Behravesh. "You have to be fairly smart in how you look at the data and how you use it."

Even though they are working with incomplete data, the agencies release preliminary reports because "everybody wants at least the best guess we can have at that point in time," Mr. Behravesh said.

The GDP number is one of three reports that typically move markets the most, according to Guy LeBas, chief fixed income strategist for Janney Montgomery Scott.

The other two are the monthly jobs and unemployment report, due out this Friday, and the Institute for Supply Management's monthly manufacturing report, which was released Monday. It indicated that "manufacturing is essentially stalled," according to a report by IHS economist Michael Montgomery.

Monday's ISM reports comforts economists who believe the Fed is unreasonably rosy.

"I'm not sure why they're as optimistic as they are," said Mr. Behravesh. He predicts the economy will grow only 1.7 percent this year, but that it could easily grow more than 3 percent next year.

Mr. Kyle said any predictions should be viewed skeptically.

"Forecasting is something economists are historically bad at," he said. "A third-grader with some draft paper and a ruler can often do as well as many economists."

Given the cloudy crystal ball, what should investors who aren't armed with an economic research squad or a high frequency trading program do?

"I would give the same advice you hear boringly everywhere," Mr. Kyle said. Diversify, save regularly and "don't respond to the short-term ups and downs," he advised.

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Len Boselovic: lboselovic@post-gazette.com or 412-263-1941.


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