Stock Analysts Start to Zig as the Fed Zags

Stocks dropped on Wednesday, even though lower interest rates are usually something that investors like. But on Thursday, investors once again seemed confident that the economy would keep growing and that the Fed's lack of interest rate increases would only juice asset prices and maintain the benign lending environment that has been a friend to large corporate borrower and subprime auto buyer alike. The S&P 500 Index rose almost 1.1 percent.

A number of Fed watchers were skeptical about its caution, suggesting its motivation seemed to be driven less by economic data and more by a mix of other concerns, including fear of market volatility and political criticism. Also, many think a good portion of the first-quarter's economic weakness is related to the government shutdown, delaying economic activity to the second half of the year.

Then the Fed sensibility struck back on Friday. A closely watched section of the Treasury yield curve turned negative for the first time in more than a decade, a reliable predictor of a coming recession, and weak manufacturing data from Germany renewed concerns about global growth. The S&P 500 lost Thursday's 1.1 percent gain, and then some.

The renewed confidence in profits is sending a premature bullish signal to investors. While earnings growth is picking up, at 5 percent it's still a lot slower than the 23 percent growth last year, though a lot of that was due to the one-time boost of the tax cut. What's more, the current estimate for the S&P 500 companies' earnings is still down from the $175 a share it was in November, according to the Yardeni numbers. Not to mention that the global economy seems weak and that a strongish dollar and continued trade tensions could disrupt foreign sales.

Investors' risk is getting caught in a Catch-22. If they bet wrong about an upticking economy, sales and profits will surely disappoint. If they are right, and the Fed stands still, labor costs and other input costs will most likely rise, eroding the still high profit margins that are baked into this year's profit-growth expectations. Fighting the Fed is often a losing proposition.

— For more Bloomberg Opinion columns visit http://bloomberg.com/opinion.

Stephen Gandel is a Bloomberg Opinion columnist covering banking and equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

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