Delivering a Better 2008 Than Is Widely Expected

Terrible day for economic news yesterday…

First, Fed Chief Bernanke announced that the top priority of the Fed is price stability. (What happened to saving the economy being the priority?) Bernanke basically said that inflation is too high, which means that the Fed is signaling that it may actually need to increase interest rates to fight inflation.

Bernanke also said yesterday that he backs Treasury Secretary Henry Paulson’s position on strengthening the value of the U.S. dollar against other world currencies — again adding to the possibility of rising U.S. interest rates. After all, rates here are half those in Europe.

The median of a resale home fell eight percent in April from a year ago, and is close to falling below the psychologically important $200,000 level. There are 4.55 million homes on the market for sale in the U.S. – a record representing 11 months’ supply. Some big name Hollywood people were in the news yesterday because they are facing foreclosure of their California homes.

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And, yesterday, New-York-based Offit Capital Advisors came out and said that it believes most of the 5.8 million subprime mortgages outstanding in the U.S. are in danger of default within the next year.

Rising interest rates, a glut of houses for sale, and five million mortgages expected to be in default, all while consumer confidence is at a 28-year low… and how does the stock market react? The Dow Jones Industrial Average was down 12.37 points yesterday, which is basically what I call a “yawn.”

The silver lining in yesterday’s “bad news” day was a report from the Institute for Supply Management, which said that its index of non-manufacturing businesses showed that the U.S. service industry expanded at a faster pace in May than had been expected. The ISM’s index of new orders for non-manufacturing industries rose in May to its highest level of 2008.

As American manufacturing jobs have moved overseas, the non- manufacturing sector in the U.S. has become more and more important. Some estimates put the U.S. service industry at about 80% of the economy. The stock market didn’t respond to the poor economic news, because it found the silver lining it was looking for in the rebounding service sector.

If there ever was a stock market that did not respond to bad economic news, most importantly the threat of higher interest rates ahead, this is it. The market’s reaction ties in with what I have been saying since late January and early February: the U.S. economy will surprise the great majority of economists and analysts by delivering a better 2008 than is widely expected.