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What Will Kill a Bull Market? Good News

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The best of times for the economy can be the worst of times for the stock market, and that may prove especially true in a market driven by trillions of dollars in monetary stimulus.

As the market keeps surging ever higher, doubling its March 2009 lows and on a high-speed journey to infinity and beyond, the biggest game in Wall Street is trying to figure out when the bull run finally runs out of rocket fuel.

The answer could well be that the rally stops when the news gets too good.

“Bull markets are born during the worst of times and they die during the best of times,” says Quincy Krosby, general strategist at Prudential Financial. “The question is, is this the best of times? We don’t think we’re there yet.”

That “yet” part of the equation is the key.

There’s no denying that the news cycle is turning positive for the economy. Housing and manufacturing numbers released this week both showed significant promise, and unemployment at least isn’t getting any worse. Earnings, meanwhile, have been strong, with more companies now beating on both the top and bottom lines.

Yet the rally has started to look tired in February, perhaps a recognition that too much good news will end up being bad news in that it will cause the Federal Reserve to take away its vaunted punch bowl and bring the party to an end.

Traders bet up fed fund futures in Thursday trading, pushing to 78 percent the chance that the Fed will boost interest rates at its December meeting. Of course, December is a long way off and the market traditionally looks ahead about six months. So the day of reckoning could be off a ways.

But the run in data and the likely Fed response is beginning to get notice in other ways.

Should the central bank indicate its easing days are over because the economy is getting better, that could be all she wrote.

“A bullish trend never ends on bearish news. It ends when a bullish news story fails to propel the market to new highs,” says Brian LaRose, strategist at United I-CAP in New York. “That is a possibility for what we’re seeing here—the final throes of this advance. You have seen bullish stories coming out, and what is the market doing? It is just sitting there.”

The Fed’s exit from its easing programs would coincide with an increase in interest rates. Until unemployment stops acting as a restraint on growth, hiking rates is the last thing Fed Chairman Ben Bernanke will want to do.

But he may not have a choice.

Both the producer prices and consumer price indices came in hotter than expected this week. On top of that, the Philly Fed’s monthly index of manufacturing activity was much higher than expected, driven by the clear inflationary forces of higher prices paid and an expectation for higher prices received among its survey respondents.

It’s no wonder that policy makers are pooh-poohing inflation threats for now, as a surge coming with high unemployment shapes up as the Fed’s worst nightmare.

Thus is the current dilemma of central banking.

“No one believes the Fed,” Krosby says. “It’s not that they think the Fed is lying. But they don’t believe they are all knowing, omniscient.”

“It’s equivalent to finding out there’s no Santa Claus,” she adds. “This is not a science. The Federal Reserve is doing what they think is necessary, the president is doing what he thinks is necessary. But the market is going to act according to what it thinks is going to happen.”

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