Steven Syre | Boston Capital

A rally vaporized

By Steven Syre
Globe Columnist / August 2, 2011

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The stock market has a very spotty record as a source of rational reflection on anything at all. That’s especially true during the dog days of summer.

But the market actually put important events in perspective yesterday, following a long weekend of numbing debt negotiations in Washington. That view: Troubling signs of a stalling economy trumped tenuous political agreements on government spending and borrowing.

As Washington became consumed by the late stages of the debt talks and the potential consequences, investors began to focus on a series of signals of a very weak economy. A modest stock market rally out of the gate yesterday morning was vaporized in minutes - literally minutes - following the latest troubling economic report.

The federal government’s money problems are real and serious. The immediate debt-ceiling crisis may be manufactured, but brinksmanship could still lead to actual economic damage. The long-term debt issues will not be solved soon or by any single political decision. Rating agencies may still strip the United States of its AAA credit rating for the simple reason that it’s undeserved.

It’s not as if markets ignored all that. Stock prices have fallen for seven consecutive sessions. Gold climbed to records last week. The Japanese yen - the currency of an economy stuck in the mud for the past two decades - was embraced as a safe haven for cash!

The debt deal reached Sunday did not resolve all those problems or allay those fears. Stock markets around the world responded appropriately yesterday morning - moving moderately higher - before refocusing on hard economic news.

The news was another bit of information reinforcing the idea economic growth is slowing to a crawl. The Institute for Supply Management produces a closely followed monthly index of US manufacturing, a number that tells you production is expanding or contracting. Manufacturing is stuck in neutral when the index reads 50.

The ISM said yesterday that its factory index fell to 50.9 in July from 55.3 the previous month. Analysts had forecast a July manufacturing index of 54.5. Those numbers paint a very clear picture.

The disappointing factory index is not an isolated statistic. Last Friday, the Commerce Department reported that the country’s gross domestic product grew by just 1.3 percent during the second quarter of the year. That’s a terrible pace of economic growth in the midst of what is supposed to be a recovery and far below rates analysts had forecast.

But wait, there’s more: The government also revised its GDP estimate for the first three months of the year. That growth rate, originally reported to be 1.7 percent, was scaled back to 0.4 percent.

For the moment, presume that the 1.3 percent second-quarter growth rate turns out to be accurate. The combined GDP growth for the first half of 2010 has been truly terrible.

All of these facts and figures matter to some degree in their own right. Collectively, they are important and worrisome. They undermine the common economic forecast that US activity would gain steam in the second half of 2010 after a slow start to the year, a forecast the stock market had baked into prices.

The new factory report suggests that the economy didn’t suddenly find the gas after the second quarter came to a close. In fact, it implies growth slowed even further. That’s why stock prices reacted instantly to the news.

The ISM report tracking factory activity in America follows the results of similar surveys in other parts of the world. Manufacturing indexes in Europe and Asia fell last month. Production slowed in some countries and actually shrank in others.

Big American companies have continued to increase profits, despite a wobbly domestic economy, by keeping costs down and selling lots of products to customers elsewhere around the world, especially in emerging markets. That will be harder to pull off in the future if economic growth is slowing or shrinking everywhere.

The stock market responds to events of the day and information of the moment. The politics of our government debt problems could shift again, for better or worse, and change the story.

Economic reports are also subject to change. It remains remarkably hard to really say how the economy will be performing three or six months in the future.

But for one day, the stock market offered a good appraisal of what matters and by how much.

Steven Syre is a Globe columnist. He can be reached at