Investors Still Cautious Despite Gains in Economy, Earnings

Strong Goldman Sachs profits and rising US retail sales fanned optimism on Tuesday that global recession may be waning, but investors were cautious about signs of a recovery and worried about a sudden pickup in inflation.

Oliver Quillia for CNBC.com NYSE traders.

Wall Street's largest surviving investment bank announced better-than-expected second quarter results, while sales at US retailers beat expectations with a 0.6 percent rise in June, boosted by a big jump in auto sales.

But a separate report from the Labor Department showed producer prices jumped 1.8 percent last month, far outstripping forecasts for a 0.9 percent gain

It was the steepest gain since November 2007 for the Producer Price Index, which measures prices received by farms, factories and refineries. Core prices, which strip out volatile food and energy costs, rose a much greater-than-expected 0.5 percent, boosted by cars and trucks.

A sluggish economy plus inflationary pressure would normally be considered a dangerous stagflationary mix, but economists see little reason to fret over price pressures when there is so much slack in the economy.

Unemployment is high and likely to keep rising, which keeps wages in check. Energy prices, the primary cause of last month's rise in inflation, have come down in the past two weeks. That should help cool prices this month.

Still, stocks were held in check as investors ignored the positive news about Goldman Sachs and retails sales and focused on inflation. Wall Street also took note that retail sales were actually short of expectations if sales of autos and gasoline are excluded.

The market moved into positive territory in late morning, but traders attributed it mostly to short covering. That's when investors who have sold stock short buy shares on the market to replace the ones they borrowed, usually at a lower price. The practice can give the market a temporary boost.

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"In terms of the retail sales numbers they were a little bit disappointing," said Tom Higgins, chief economist, Payden & Rygel, Los Angeles. "We had been hoping to see some growth in core sales ex-gas and ex-autos but it's still deteriorating."

Treasury Secretary Timothy Geithner, meanwhile, said Tuesday that a global assault on recession was making headway and acknowledged that Washington bore a special responsibility to help spur a recovery in the world economy.

"The force of the global recession is receding," Geithner said in a speech in Jeddah, Saudi Arabia. "For the first time in several quarters, the IMF and a range of private analysts are starting to revise up their forecasts for growth in the second half of this year and next."

As he did in London on Monday, Geithner accepted the global economy faced severe problems but was reassuring so long as "steady, forceful and sustained" support continues until private investment and spending lead a recovery.

Goldman Sachs reported a 33 percent rise in earnings as a strong gain in trading was offset by a one-time charge to repay government loans.

"They're terrific numbers...I think things are very fragile but they manage to make money in all environments which is what you're supposed to do." said William Smith, chief executive of Smith Asset Management in New York.

"You're going to see absolutely enormous numbers coming out of the money centres, including Citigroup," he added.

Goldman, the first major U.S. bank to report quarterly earnings in the current cycle, saw its performance bolstered by improving markets and strong trading results.

Stronger-than-expected first quarter results from financial companies sparked a rally in the sector which spread to the rest of the stock market.

Department stores and restaurants were among the laggards, suggesting that consumers remained reluctant to resume discretionary spending despite signs the recession may be drawing to a close.

Officials and investors alike are on tenterhooks, waiting to see whether a tentative upturn in economic data in recent weeks means an eventual end to the worst downturn since the 1930s.

Many fear that it is merely a short-lived blip, sustained only by the trillions of dollars that governments around the world have poured into saving their banks and stimulating their economies -- borrowed money that will take years to repay.

—Reuters contributed to this story.

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