Why You Should (or Shouldn't) Care About the Philly Fed Index

At least part of the reason behind Thursday’s brutal session in the stock market was the big surprise from the Philly Fed General Business Activity Index. While there are boatloads of economic data releases each month, this report took on added importance for traders due to the fact that it was an August survey.

Given that a good part of the summer swoon can be tied to what traders refer to as “growth concerns” (i.e. whether or not the U.S. economy will slip back into recession) going forward, the more recent data points are of added import. It is for this reason that the market chose to focus on the August Philly Fed Index as opposed to the July LEI (Leading Economic Index), which was also released on Thursday – and actually came in above expectations.

The problem with the Philly Fed index was both the magnitude of the “miss” and the absolute level of the index. Analysts had expected to see a decline from the July reading of +3.2 down to +2.2. While this is not a great reading, anything above the zero-line is generally preferred.

But instead of a reading bordering on weakness, the markets were treated to an out-and-out disaster as the index plunged an eye-popping 33.9 points to -30.7. This was not only the lowest reading since March 2009; it was also the fifth biggest drop on record and signals a significant slowdown in business activity. And this time, there was no earthquake to blame the weakness on.

Okay, it was a bad number, so what, right? The problem is this: Each and every time the index has reached this level, the economy has either been in, or about to enter, a recession. Uh-Oh!

Then when you add in this week’s Empire Manufacturing Index, which is designed to indicate the state of the manufacturing sector in the New York region, and the big drop in bond yields, well, it’s beginning to feel like the “R” word argument should be taken seriously.

Lest we forget, the Empire Manufacturing Index came in at -7.72, which was well below the consensus estimates and marked the third straight negative reading. And up until the May reading, the indicator had been positive each and every month since November 2010.

However, there are those who assume that the Fed will once again ride to the rescue with some sort of stimulative potion designed to get the economy and the market back on track. Traders are quick to recall that it was at the end of August last year when Ben Bernanke first hinted at QE2 from an economic gathering in Jackson Hole, Wyoming.

The argument that the Fed will once again mount their white horses is a little tougher this year. First and foremost is the fact that part of the argument for QE2 was that inflation was “too low” and that since the Fed’s dual mandate is to keep stable prices and full employment, Bernanke figured he could buy a trillion dollars in bonds in an effort to stimulate the economy and the resulting increase in inflation wouldn’t be a bad thing.

Unfortunately though, Bernanke only got half of the formula – and the wrong half at that. Asset prices such as stocks did rise for a while but the economy didn’t really improve. Oh, and some inflation definitely cropped up along the way. This week’s CPI/PPI numbers show that while inflation isn’t exactly a problem, it also isn’t below the Fed’s target anymore. Thus, unless Gentle Ben can come up with another reason to keep buying bonds, further Fed stimulus might be off the table.

If you are scanning the horizon for the cavalry, you can probably also count out any stimulus from Washington. Since the children can’t seem to play together well enough to avoid the first debt downgrade in our nation’s history, it isn’t likely that they are going to start writing checks to American citizens again.

So, should investors brace for crash? Is there no hope? Is a bear market and another recession in the offing? Frankly, we’re torn on this issue and would prefer to wait for more data before taking a stand. Call us wishy-washy if you must, but it is important to remember that the disastrous Philly Fed Survey was taken during the August 8 – 16 period, which, as you might recall was during the worst part of the 11-day, 16% dive in the stock market. So, respondents couldn’t be blamed for being downbeat.

Regardless of whether or not the U.S. is heading for another recession, the key is that the U.S. economy isn’t exactly hitting on all cylinders right now. So, with high unemployment, a lousy housing market, a stagnating economy, the Fed on the sidelines, and Congress unable to agree on what to order for lunch, one has to wonder where the growth is going to come from that would drive stock prices significantly higher.

 

  S&P 500 - Last 12 Months

 

 

Remember, you are in control your email alerts! You can receive alerts for more than 25 free research report alerts including: The “10.0” Report, The Insiders Report, ETF Leaders Report, and The Focus List.