Why the Dow Jones Is Flat Despite the Terrible GDP Report

The Dow Jones Industrial Average (^DJI 0.40%) is just above breakeven, and the S&P 500 (^GSPC 1.02%) has edged into record-high territory after GDP for the first quarter was revised steeply lower, much worse than analysts expected. The stock markets shrugged off the bad news and are continuing to rise. As of 1:30 p.m. EDT the Dow was up 14 points to 16,647. The S&P 500 was up four points to 1,913 after hitting a new intraday high of 1,915.78 earlier in the day.

There were three U.S. economic releases today.

The one getting all the attention is the GDP revision, which, at a 1% drop for seasonally adjusted annualized GDP, was far worse than analyst expectations of a 0.6% drop. Analysts began revising their GDP expectations downward earlier in the month after the trade deficit proved much worse than the Bureau of Economic Analysis assumed in its the first estimation of Q1 GDP. Goldman Sachs cut its Q1 GDP forecast to -0.6% from -0.3%, and JPMorgan Chase cut its forecast to -0.8% from -0.4%.

Source: TradingEconomics.com.

The reason the stock market is not down today is that the GDP decline is being attributed to the abnormally harsh winter, which shut down various parts of the country that normally don't get snow. Mainly though, the market is unchanged as the second and third estimates of GDP are backward-looking indicators, while the market is focused on the future. The terrible first quarter has already been reflected in companies' Q1 earnings reports over the past few weeks, so it doesn't really tell us anything new.

Going forward, the economy is expected to rebound, with investment picking up after companies held off during the winter. The important thing to remember is that the economy continues to slowly grow and the labor market also continues to slowly improve. The slowly growing economy, though, will make it hard for the market to hit analysts' lofty expectations of 10% earnings growth this year for the S&P 500 as a whole.

While growth this year may not be as rosy as previously expected, some companies are taking action to improve their stock prices. Leading the way among Dow stocks is Merck (MRK 0.37%), which is also today's top Dow stock, up 1.8% this afternoon. Merck has been refocusing itself around a core strategy of targeting high-growth, challenging areas, where its size and know-how give the company a large moat. The company is focusing itself around animal health, cancer drugs, cholesterol drugs, diabetes drugs, and vaccines. Merck has been selling off more commoditized business where it is not a global leader. If Merck's drug trials go well and the company is able to replenish its pipeline, Merck could continue to crush the Dow for years more as it grows from a smaller capital base.

Bottom line
There are still pockets of growth in the markets, but they are getting harder to find. While I continue to believe the stock market is overvalued, opinions differ. But with the Federal Reserve committed to low interest rates and pumping money into the economy, who knows how high the market can go? One thing is for sure: It's getting harder and harder to find great companies at good prices.