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The Disconnect Between Stock Market Perception and Economic Reality

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This week Nasdaq soared to record highs, cracking the 6,000 ceiling for the first time. The Dow Jones surged as well, gaining 1.1% Tuesday. Earlier this year, the Dow shot above the 21,000 mark and hit record highs 12 days in a row in February. Despite these impressive numbers, there are increasing signs that the economy is tanking. In fact, there is a huge reality disconnect between what is going on in the economy and the soaring stock markets.

The US economy barely grew in the first quarter. The Commerce Department announced Friday that GDP increased by just 0.7% in Q1 of 2017. Analysts had projected 1.2% growth. It was the weakest Q1 performance in three years.  According to the AP, the slowdown primarily reflected slower consumer spending, which grew by just 0.3%.

Of course, pundits are trying to spin the bad news. The AP said analysts blamed the drop in consumer spending on “the unusually warm winter, which meant less spending on utility bills,” and insisted economists think the slowdown is only temporary. But other news that came out this week doesn’t paint a rosy picture.

There was weaker than forecast data on durable goods orders. Non-defense capital goods orders excluding aircraft increased just 0.7% in March. Analysts had expected 1.2% growth. It was the poorest showing in more than seven years.

The Kansas City Fed composite manufacturing index also crashed, falling from 20 in March to 7 in April. Analysts had expected only a modest drop to 17. Production plummeted from 37 to 12. New orders collapsed from 32 to 8. According to ZeroHedge, the average workweek shrank for the first time since November and the overall number of employees fell.

There are also some dark clouds hanging over the housing sector. Pending home sales fell 0.8% from February to March. According to the National Association of Realtors, the number of signed contracts to buy existing homes in March was just 0.8% higher than a year ago. According to CNBC, tight inventory and rapidly increasing prices are squeezing the housing market.

“Affordability is clearly worsening, and that is sidelining more and more buyers. A report this week from real estate brokerage Redfin showed a drop in the number of home tours requested in March and the number of potential buyers writing offers. Mortgage applications to purchase a home are also weakening.”

As we reported recently, the retail sector is in a free-fall, and the check engine light is also on for the auto industry. Then there is the ticking debt bomb.

As Jim Grant put it in an interview last year, the horse of speculation is ahead of the cart of enterprise. In other words, even though stocks and other asset prices continue to rise, creating the illusion of economic prosperity, the actual underlying economy is a mess.

So, how do you account for the massive chasm between the stock market and economic reality? The Federal Reserve created a phony wealth effect by pumping up stocks and other asset markets. Analysis last year by Yahoo Finance showed 93% of the entire stock market move since 2008 was caused by Federal Reserve policy.

So far, the Fed has managed to keep the air in the stock market bubble. The so-called Trump effect has also blown more hot air into the balloon. But as political realities run headlong into Trump’s ambitious campaign promises, the bloom on the rose is wilting. If the Obamacare repeal debacle is any indication, the administration is going to have a hard time fulfilling promises of tax reform, stimulus spending and an end to the Affordable Care Act.

At some point, reality will catch up with perception. The next sound you’ll hear is a great big pop.

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