There’s no doubt about it, this situation is a quagmire. Economic growth is the slowest it’s been in years, but if the Federal Reserve slashes interest rates to get things going, it risks rising inflation, and that kills economies over the long term.
What’s evident in the latest GDP numbers is that the real estate sector of the economy is taking a real bite out of the entire economic landscape. Not surprisingly, this important sector of the economy is influenced significantly by the current level of interest rates. Even a quarter-point move in interest rates has a material effect on mortgage demand.
So, faced with slow economic growth, a weak real estate market, and the threat of inflation, what is an investor to do? In my view, the only way to play the current situation is to follow the leadership in the stock market, not the economic numbers.
It used to be when bad economic news hit the wires, the stock market went down. Not so today. The stock market is looking beyond the current numbers. What I see the stock market predicting is that economic growth will improve and not get any worse. I see this stock market saying that the real estate market is a concern, but housing prices had such a strong run over the last five years there’s plenty of room for a little correction.
I think that most stock market participants are holding out hope for an interest-rate reduction in the fourth quarter this year. Already, the stock market is looking to that quarter — and into 2008 — for its direction. The way the broad market averages have performed over the last few months, the market is saying that it isn’t worried, and therefore individual investors shouldn’t be either.