Gail MarksJarvis: The economy looks strong. Why arenít investors happy?

McClatchy-Tribune Information Services

August 10, 2015

Just as analysts were beginning to fixate on risks to the U.S. from a fragile global economy, a new report Wednesday melted away the gloom.

At the moment, the U.S. appears to be in surprisingly good shape. In fact, the service economy ó or the great majority of the U.S. economy ó surged to the highest level in a decade in July, according to the Institute for Supply Management non-manufacturing report.

The ISM report, closely watched by economists and investors, shocked analysts because it indicated surprising strength across a wide range of industries ó from education services, entertainment and health care, to the wholesale trade, retail and transportation. In addition, hiring continued its 17-month climb, reaching the highest level since 2005.

The report "was good news all-around," said Ksenia Bushmeneva, economist for TD Economics. "There is definitely no summer lull in the U.S. services sector."

Economist Jim OíSullivan of High Frequency Economics said: "The data show good momentum."

In contrast, the nationís manufacturing economy has not been strong. Economies in Asia, Europe and Latin America have been reluctant to make purchases; a strong U.S. dollar has made American products expensive to foreign customers.

The service economy is "less exposed to weakening in foreign demand," said OíSullivan.

While the Dow Jones industrial average first surged 100 points upon the release of the service sector data, the gains gave way to concerns from investors who fear the data will provide a green light for the Federal Reserve to start raising interest rates.

The Dow closed down 10 points to 17,540.

Interest rates have been near zero since the Fed started using stimulus to bring life to the recessionary economy. As low rates have persisted, theyíve been a knee-jerk signal to investors to buy stocks even when the economy has been troubled. With bonds paying little interest due to the Fedís low-rate policy, stocks were perceived as the only game for investors who wanted to earn some income.

Now, if the Fed takes the pacifier away by raising interest rates in September, there is a concern that investorsí knee-jerk reaction will be to sell stocks. Presumably the stock market would dip from recent lofty levels. Yet just how far or how sustained that decline might be has been hotly debated. Some analysts point to history showing that the stock market typically rises, rather than falls, when the Fed starts raising rates, because the Fed action means the economy is strong. Other analysts say history is worthless because of unprecedented action by the Fed during the last few years to manipulate the economy and the stock market after the recession.

With investors anticipating a rate increase soon, the stock market has stalled this year. But the Standard & Poorís 500 has climbed about 90 percent during the last five years.

Fridayís unemployment rate will be watched closely for another signal about the Fedís next step. Until recently, Federal Reserve Chair Janet Yellen has said there were too many people without well-paying jobs, so the Fed had to continue to keep interest rates low. Her tone seemed to change after the Fedís July meeting. On Tuesday, Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said itís time for the Fed to start raising rates.

Economists increasingly are expecting the Fed to begin raising interest rates in September. They think concerns will persist about the potential drag on the U.S. from weakness in the global economy but assume that modest strength in the U.S. will last.

In particular, despite an ADP jobs report Tuesday that came in below expectations, analysts are assuming Fridayís unemployment report will be strong.

"We do not believe this Fridayís jobs report will be weak," Deutsche Bank economist Joseph LaVorgna said in a note to clients Wednesday.

He noted that very few people have lost their jobs recently. "Initial jobless claims remain near a 42-year low," and the taxes people are paying to the IRS from their paychecks have "been growing at a healthy 5 percent annual rate."

Further, he added, "July motor vehicle sales were a robust 17.5 million units, which bodes well for hiring because households typically do not purchase big-ticket consumer goods if job and income prospects are not improving."