Aside from Friday's massive selloff on the street I have noticed a trend on wall street in the last couple of weeks. The street has gotten into the frame of mind that poor economic news is good news because it means that the Federal Reserve has more ammunition to continue to cut interest rates. To a degree this is understandable because the market clearly loves low interest rates, but to fall too deeply into this trap is very dangerous.
Why is it dangerous to fall deeply into the bad news is good news trap? Quite simply, buying stocks on continued bad economic news is a very questionable proposition. If economic conditions continue to worsen and companies start warning of earnings misses across the board, the bad economic news will quickly become bad news for the stock market. In this kind of environment, stocks can unwind any gains on potential interest rates in a huge hurry.
Recently we have seen consumer confidence take a dramatic plunge. This is a huge caution flag. Consumer confidence is one of the best predictors of future retail sales, which are absolutely essential to the economy. We have already seen the employment numbers weaken significantly, and as I have stated here before, I simply don't believe the economy can hold up without the jobs market holding up.
Taking a really long-term outlook, it is quite possible that the Fed and its continued interest rate cuts will turn the economy around a few quarters down the road. The problem is that if the continued poor economic data pours in, there is likely to be a significant amount of pain between now and that time. As the televsisions talking heads continue to say that this economic news is great because it means lower interest rates, be wary that this news could instantly change to very bad news and a lot of pain in your portfolio.
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