Why the stock market is hitting new highs

INDICATOR: February Supply Managers' Non-Manufacturing Survey/CoreLogic Home Price Index

KEY DATA: ISM (Non-Man.): up 0.8 point; Orders: up 3.8 points: Employment: down 0.3 point; Inventories: up 7 points/Core Logic (1 '12-1 '13): up 9.7%

IN A NUTSHELL: "If you are wondering why the stock market is hitting new highs, look no further than the economy as all segments seem to be growing faster."

WHAT IT MEANS: The government may be in gridlock but the private sector is not. It seems that despite the worries about sequestration, or maybe because there are few concerns about it so far, business activity is improving. The Institute for Supply Management's February reading on the non-manufacturing portion of the economy improved solidly, mirroring a similar gain in the manufacturing sector. Leading the way was a large increase in new orders. Only thirteen percent of the respondents indicated that demand moderated over the month. While the employment index eased back, it still remained near record highs. And inventories are building. Remember, a sharp cut back in inventories was a primary factor in the weak fourth quarter GDP number. As expected, inventories are being rebuilt and that should provide a nice boost to first quarter growth. With order books filling, activity in the construction and service portion or the economy should continue to improve.

In a separate report, CoreLogic indicated that home prices continue to jump, rising solidly in January. In addition, the nearly ten percent gain over the year was the largest since the bubble month of April 2006. Even excluding distressed homes, prices were still up by 9%, a clear indication that the housing market is making huge strides in its recovery. Indeed, excluding the investor driven distressed home market, no state posted a decline in prices over the year.

MARKETS AND FED POLICY IMPLICATIONS: The stock market is in full bloom, the Fed is funneling money into the economy at an impressive rate and the economy is responding to those trends. The improvement in both of the Institute for Supply Management's indices point to an economy that, at least so far, is shrugging off tax increases and government spending cut issues.  Indeed, the only impediment to growth appears to be negative fiscal policy. How much of a negative impact that the sequestration will have on activity will depend upon how long it goes but the impacts will be measureable. The unfortunate aspect of the cuts is that without them, it appears as if the economy would have changed gears this year, going from recovery into full-fledged expansion. That may not happen but we will still grow nonetheless. It is just that job gains will not be as robust and the unemployment rate may not fall as much. That also implies that tax revenues will be less than they would have been and spending on programs such as unemployment insurance could be higher. There is no such thing as a free budget cut and the timing, type and context in which spending cuts are made can be as important as making them.