The stock market bounced back quite a bit on Wednesday, with headlines touting the Dow’s single-day record gains of over 600 points. (This conveniently ignores that the DJIA lost over 1,000 points in the two trading days previous.) The benchmark U.S. indices (including the Nasdaq Composite and the S&P 500) were trending about another 2% higher on Thursday after weekly jobless claims fell and GDP readings for the second quarter were revised upward—far upward, in fact, almost inconceivably higher to the point of questioning how the original figure could have been arrived at so far from the “actual” revised number.
After Q2 GDP was initially reported at 2.3%, the data was revised to an even more robust 3.7% on Thursday. This follows the upward revision of Q1 GDP, as well, which was first reported to be slightly negative before the updated figures showed modest 0.7% growth. This was a fairly hefty revision in its own right, not just because it went from a negative reading (contraction) to positive (expansion) but also because the initial number was supposedly off by almost 1 percentage point (100 basis points)—a massive revision. This time around, the revision is over 1% higher, 140 bp.
If we’re to believe that the latest GDP numbers represent a clearer version of reality within the economy, then why on earth do we trust the original data reported weeks earlier that the U.S. Bureau of Economic Analysis clearly believed to be accurate at the time? Nonetheless, Wall St obviously took a liking to the new number, which beat even the most exuberant expectations of economic analysts.
Weekly jobless claims also fell by 6,000 claims to 271,000, continuing to show very little slack in the labor market. Official unemployment numbers remain subdued, although measures such the labor participation rate and underemployment rate—workers who may have part-time employment, but are struggling to find the amount of work they need—still leave some improvement to be desired. At any rate, the employment situation is exactly in the Federal Reserve’s target range; it’s chronically low inflation (disinflation) that is weighing heavily on the Fed’s decision about when to raise interest rates. Part of the rally for stocks appears to be fueled by a renewed expectation from market participants that the central bank will delay raising rates until next year.
Interestingly enough, the roughly 2% expansion of the U.S. economy over the first half of 2015 closely matches the economy’s performance over the same period a year ago: after an ugly -2.1% drop in GDP during Q1 2014, the second quarter largely made up for it with a 4.6% spike for roughly the same 2% advance over H1 2014. Last year, the third quarter followed that up with a 4.3% expansion.
Classic “Market Overshooting” Pattern
There is, however, the potential for the resurgence in the U.S. equities market to rapidly turn the rate-hike-expectation tide back the other direction. The longer the rally sustains, the more likely that the markets will begin to again expect an imminent move by the Fed on raising rates. With the economy offering investors plenty of mixed signals, it is only a natural market force (borne of both human nature and the trial-and-error mechanism of the free market) for traders and investors to overshoot the real target level when there is a wave of buying or selling momentum. Invariably, markets overshoot their equilibrium on big movements before correcting back toward the right level. Though it seems like a bit of groping in the dark, it is the most natural and accurate means of price discovery in a truly free market.