(July 24) – “The U.S. economy is slowing to a noninflationary pace, the Federal Reserve is happy, so stocks should do much better than they have so far this year, right?” That’s the question Grep Ip asks in today’s Wall Street Journal.

“Not so fast.”

“As the signs have built in recent weeks that economic growth has eased substantially from its breakneck pace of last fall and winter, investors have cheered. The Standard & Poor’s 500-stock index is up 9.1% from its April low, the Dow Jones Industrial Average is up 4.2% in that period, and the Nasdaq Composite Index 23.3%. And why not? GDP grew at a blistering 5.5% annualized rate in the first quarter, but economists now think it has slowed to 3.6%, according to Blue Chip Economic Indicators, enough to keep inflation from flaring up and interest rates from rising.”

“But we’ve seen this before: last year and the year before, to be precise. There’s strong evidence temporary factors — specifically, the weather and taxes — have produced the pattern of strong winters followed by weak springs. In both 1998 and 1999, the slowdown proved temporary and growth rebounded in the second half of the year.”

“If this year follows the pattern, investors’ current optimism about inflation and interest rates could quickly evaporate, and stocks could experience a second half just as rough as the first.”

“Economists at Goldman Sachs Group have found that unusually warm winters, such as those of the past three years, generate higher than normal levels of construction and retail spending in the first quarter. But much of this is simply moved forward from the spring, producing a slump in activity in the second quarter.”

“Based on typical seasonal patterns, construction and retail spending were expected to fall 19.5% and 12% in the first quarter of this year, they note. But because last winter was the warmest in the 106 years for which records exist, construction fell only 14% and retail sales by 9%. When government statisticians adjusted those figures for the usual seasonal decline, they came up with outsize ‘seasonally adjusted’ gains. But they couldn’t be sustained, and both construction and retail sales have eased in the second quarter.”

“As the weather’s impact ‘washes out of the system, the numbers should return to a somewhat stronger pattern from what we saw in the second quarter,’ says Ed McKelvey, senior economist at Goldman. ‘You’ve got this perception that suddenly the Fed doesn’t have to do anything based on growth slowing for one quarter. It seems to me the risks are still tilted to’ interest rates going up.”