The Perils of Pessimism: Are Investors Ignoring the Good News?

It's easy to be pessimistic these days, with financial markets tumbling amid news of tragedy and instability. But there are good reasons for investor optimism too.
It's easy to be pessimistic these days, with financial markets tumbling amid news of tragedy and instability. But there are good reasons for investor optimism too.

The financial markets have been in a sour mood lately. Major U.S. indexes tumbled this week, giving back all of the year's gains, and investor confidence has plunged.

It's easy enough to understand the pessimism. After all, the markets are famous for being frenetic, and the spate of tragedies unfolding across the globe certainly hasn't helped.

Early optimism about democratic reforms in Middle Eastern countries, à la Egypt, has instead morphed into a bloody civil war in Libya. Oil prices have surged as a result of growing instability in the region. And if that weren't enough, a brutal earthquake led to a tsunami that killed thousands in Japan -- and raised fears of a major nuclear catastrophe.

But investors would be wise to stave off the gloom with a more levelheaded approach. While the improbable sequence of tragedies is dominating the headlines today, a booming world economy -- one that is sparking a manufacturing renaissance in the U.S. -- may end up being the bigger story for the markets over the intermediate term.

More Evidence of a Strong Recovery

A roaring result for the closely watched Philadelphia Fed index Thursday provided the latest evidence that a strong recovery is under way. A key gauge of the health of the manufacturing sector, the index posted its fastest expansion since 1984. That's after it came in far ahead of economist's expectations the month before, as well.

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"Starved of industrial activity in the depths of recession, manufacturing is feeding the recovering U.S. economic beast," analysts at TD Economics write in a research note.

The rapid growth of the middle classes around the world, along with the resurgence of U.S. consumer spending, is fueling demand for goods like cars and auto parts.

These sectors suffered a particularly brutal downturn during the depths of the recessions, as shell-shocked consumers pulled back and a credit crunch made financing even harder.

"But as the ranks of consumers in the market for new vehicles swells, and with banks more willing to finance their purchases, it is no surprise that the auto industry is roaring back to life," TD Economics analysts write.

Why Disaster Isn't Imminent

For the pessimistic pundits who get more airtime when markets fall, the strong economic growth is merely the prelude to another disaster. And runaway inflation -- which has long been predicted, but with little basis in reality -- is usually named as a top contender.

As the consumer-price-index data released Thursday shows, core inflation remains tame. True, food and fuel prices have risen sharply. But those hikes aren't due to a big trend; instead, crop shortages -- caused by a severe winter -- and the turmoil in the Middle East are driving those prices up.

With plenty of idle capacity waiting to come online, the U.S. economy has considerable room to grow before inflation becomes a widespread concern.

Industrial production remains 5% off its peak prior to the recession, and a lower-than-average amount of capacity is currently in use, according to TD Economics. "Until these ceilings are breached, inflationary pressures should remain muted," they write.

Amid the horrid, moving footage coming in from all over the world, it's no surprise that markets and investor sentiment have tumbled lately. Still, investors would be far better served by paying closer attention to the cold, hard facts that paint a far brighter picture instead.