Lots of Good News for Stocks, Shame About the Collapse

Last Updated Jan 17, 2010 4:48 PM EST

My last post took note of the lukewarm reaction of the stock market to the improving economic backdrop. It's a bad sign when investors get just what they want and are unmoved by it.

"...the stock market seems to greet each piece of good news with a resounding two cheers," the post said. "It rallies almost every time, often sharply, but only for a few minutes or an hour or two, before flattening out and occasionally surrendering the gain."

There were hardly any cheers at all on Tuesday, and rather than being unmoved, investors were moved to sell stocks vigorously. That was in spite of economic reports that were uniformly positive and better than expected.

Topping the list was the first increase in 19 months for the Institute for Supply Management's manufacturing index, which came in at 52.9 for August, well above the 50.5 consensus forecast. Contracts to buy previously owned homes also easily exceeded projections, rising 3.2 percent in July to their highest reading in more than two years.

The International Monetary Fund upgraded its forecast for 2010 global economic growth to slightly less than 3 percent, according to the Wall Street Journal, from 2.5 percent in July and 1.9 percent in April.

The stock market was pleased enough to move nearly 1 percent higher just after the two pieces of U.S. data were released. It soon reversed course and sank to its lowest level in two weeks. The Standard & Poor's 500-stock index closed down 2.2 percent on the day, leaving it roughly where it was a month ago.

The media offered one of the usual excuses for the decline: concern about the health of banks. Bank shares fell by more than twice as much as the broad market, but there was no clear reason why concern would be any greater today than it was yesterday or is likely to be tomorrow.

A more reasonable explanation is that stock prices already account for a substantial recovery in the economy and banking system. The market may bounce back - it has done so often enough in the last few months - but the sharp fall after a slew of promising reports suggests that it will take more than good numbers to ignite a new rally. A sharp correction may do the trick.