Wednesday market watchers and traders spent the day eagerly awaiting comments from the Federal Reserve’s latest Open Market Committee meeting. Apparently they liked what they heard, because major indices closed the day with strong gains.

The actual Fed statement is quite brief, so I am going to include the full text here so you can judge for yourself how to interpret the committee’s comments.

“Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

“The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.”

Although the Federal Reserve is trying to put a positive spin on the current economic situation, there is certainly nothing definitive in this statement to verify that the economy truly is improving. And comments like “ongoing job losses, sluggish income growth, lower housing wealth, and tight credit” might lead one to believe there is yet little reason for optimism. In fact, in some of the areas where the Fed statement cites improvement, there are substantive contrary indicators.

For example, the statement reads: “Household spending has continued to show signs of stabilizing.”  Yet today a new report from the Commerce Department showed that July retail sales fell 0.1 percent. Economists had expected a gain of 0.7 percent.

In spite of the Federal Reserve’s announced efforts to provide props for the housing markets and mortgage lending, the National Association of Realtors announced Wednesday that median home prices fell a record 15.6% during the three months ended June 30, compared to the same period in 2008. Median prices rose slightly from the first quarter of 2009, but that gain can be primarily attributed to season factors.

My personal impression is that most of the announcements that are being heralded as positive signs for an improving economy are really of the “less bad” variety: as in, the economy continues to lose ground but it is less bad than earlier. Or, jobless rates continue to rise, but it is less bad than expected.

Another thing that concerns me is an impression that most revisions to recent economic reports are negative. For instance, last week second quarter GDP was announced at -1%–better than expected. But first quarter GDP was revised downward from -6.4% from -5.5%–significantly worse than previously reported.

In my home state of Utah, the Department of Workforce Services Wednesday reported that job losses in the first quarter were 50,247 rather than the 26,000 that was reported earlier. That is almost double the previous number, in case someone is counting. The state’s senior economist blamed the data error on changes to the surveying method enacted by the U.S. Department of Labor Statistics.

The bottom line for our clients and friends is that while major indices seem to still want to go up, technical and cyclical indicators show that the current move is very extended. Virtually all economic fundamentals still reflect weakness and high risk for investors. We continue to anticipate that a sharp and severe market correction remains a possibility. It might not occur, but we must continue to follow a risk averse strategy under these conditions.
F.S.