Stocks And Bonds Spike On The 'Bad Is Good' GDP Revision - Don't Expect The Rally To Hold

Includes: GLD, SPY, TLT
by: Joseph Stuber

The 1st quarter downward revision to GDP and personal consumption expenditures suggests the economy is in a real mess and getting worse. The revision puts 1st quarter GDP at 1.8% - down from the last report at 2.4%. The reason - personal consumption expenditures were revised down to 2.6% from 3.4%.

Is that really a surprise? I don't think so. Remember we did raise taxes on everyone. Oh, and we did cut spending across the board with sequestration cuts. In other words, we went over the fiscal cliff but the market didn't care as we rallied roughly 15% on the "bad news is good news" theory.

One wonders just how long this utterly absurd and irrational market action can continue - at least I do. Where is the recovery? But then we don't need a recovery right? After all we have the Fed flooding the private sector banks' excess reserve accounts with QE. Not to worry that the money never makes it to the real economy and is totally useless as a driver of GDP - we believe in the Fed anyway.

And that is what creates bubbles - investors bidding stocks up on a hope and a prayer - not on the basis of any fundamental reason to do so. A look at the last 2 quarters based on the most recent revision to GDP produces a 6 month average GDP growth of about .95%.

Keep in mind we haven't seen much in the way of an impact to the sequester as the cuts began in March and the full impact will likely be seen in the 2nd quarter numbers. One wonders how that will affect the 3rd quarter average. Probably not much, actually, as the 2nd quarter should be down from the 1st quarter but even a 50% drop from the 1.8% level will leave us at about 1% on average.

That is a long way though from the Fed's 2.3% to 2.6% overall 2013 growth forecast. The good news is that corporate profits weren't so bad - income after taxes and not adjusted for inventories and capital consumption decreased 1.4% from the fourth quarter of 2012. That, of course, is a decrease, though, and as stocks have been moving much higher, profits have been moving lower, creating a multiple expansion that is only rivaled by the dotcom bubble and the bubble in the 20s that preceded the depression.

So here is the market's response on the open this morning based on the really dismal report - we are up and up a lot. Sheer nonsense and based on investor sentiment that suggests the Fed will have to recognize that the economy is not improving and will continue to do more absolutely useless QE by continuing to expand excess reserves.

The truth is the Fed's policy is not driving GDP and corporate profits are contracting. This is not good news and the market's response is the same as it has been - the "bad is good" theory of investing. Quite honestly this market response might have made sense a year ago when there was still some hope that fiscal and monetary stimulus would actually impact the real economy.

For what it's worth, the Fed knows the policies haven't worked and that we are precariously close to a deflationary spiral. After 5 years, a 1% 2 quarter GDP average doesn't support the idea that QE has had an impact on economic growth.

Here is the price action for gold (NYSEARCA:GLD), bonds (NASDAQ:TLT) and stocks (NYSEARCA:SPY) based on the dismal GDP revision this morning, based on the 5 minute chart. The "bad is good" knee jerk response isn't likely to hold as large chart gaps are all over the place here:

(Click to enlarge)

I rarely make a short term trade recommendation but my guess is that fading this wholly irrational response to the "bad is good" GDP report and personal consumption spending numbers will yield a very healthy short term profit by Friday's close.

Disclosure: I am long FAZ, TZA, TECS, VXX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.