How We Will Know When Economic Recovery Begins

By Dr. Declan Fallon

Based on John Murphy's definitions, let's take a look at the economic picture and see where we lie and what to look for when the recovery begins.

First up are four factors Murphy has defined for monitoring the economy:

click to enlarge


As John Murphy states in his book "Intermarket Analysis"

Consumer Expectations are very important because consumer spending accounts for two-thirds of the economy.

Consumer sentiment first bottomed in June 2008 then staged a modest bounce; it subsequently retreated to June lows in November and has only recently started to recover. It is in the process of "reviving", but likely won't classify as "rising" until it gets past 70. On past form this could take another 6 months.

What of Industrial Production?

Industrial Production (IP) is one of the most widely followed measures of economic activity. During a recession, with business and consumer spending on the decline, Industrial production is falling. When IP starts to rise, it is an early sign that the economy is recovering.

Little comfort in these figures. The 3-month trend is squarely down and the monthly data is riding below the average. When individual sectors are considered, only Ultilities are growing, these having bottomed in August 2008. Consumer confidence leads IP so it could be 6-12 months before we see a meaningful recovery in IP. This will delay the recovery because by definition, IP is still "falling".

Interest rates are relatively straightforward:

A rapid rise in interest rates usually occurs in the late stages of economic recovery, which contributes to the eventual recession. Conversely, rapidly falling interest rates during a recession contribute to the eventual economic recovery.

Looking at the iShares Lehman 20-yr+ Treasury ETF (TLT), a clear top in long prices (bottom in yield) can be seen in December 2008. Tops rarely confirm in a 'V' fashion so a second rally may kick off around $100 to take it close to $123, although the second rally may stall out around $118. Interest rates look to be "bottoming" but this process will probably take longer than people expect, given the Fed has no more leeway to lower rates any further than it has.

As for the Yield Curve:

During an economic recovery, the yield curve has a tendency to flatten out. This means that short-term rates are rising faster than long-term rates and the spread between the two flattens. The crucial point comes when short-term rates exceed long-term rates. It is a dangerous situation called an inverted yield curve and is usually an early sign of an economic contraction

The current Yield Curve looks decidely 'normal' and fits with the definition of a Recession.

From these four factors it would appear the next recovery will lead with Consumer confidence pushing above 70, followed by an uptick in IP. Interest rates are already in a favourable environment for a recovery (along with depressed commodity prices).

Value buyers may want to sniff around Industrial (XLI) and Basic Material (IYM) stocks in anticipation of a recovery. The action of Institutional buying will reflect in the charts with flat-lined moving averages and a major capitulation low holding (last November?) as support.



For the Basic Materials group I have made a YourCall for a move to $61.59 wth a stop at $30.49 within the year. It's a tall order but it is nicely set for a decent 2009.

Consumer data sourced from Reuters.
Industrial Production from the Fed.
Yield Curve from Stockharts.

Comments

[Marcap:]

When the media is no longer filled with bad news of more layoffs, foreclosures and bankruptcies, and the banks are out of trouble and once again lending money, we will know that Economic Recovery has begun. Until then, there will be no recovery.

Feb 04 03:53 PM

[Bruce Pile:]

The stock market will turn many months before the economy. And about the first place a turn occurs in the market is detected by just following the money. Charles Biderman, CEO of TrimTabs is seeing no such turn yet (Barron's 2/2/09). There isn't that much cash on the sideline when you tabulate how much is earmarked against redemptions and for purposes other than plowing back into stocks. His investment advice is to short the market!

But on the bright side, there will be a bear rally worth investing in (meaning it will run good for months), probably sometime this year. The nice thing about the stock market is that it always spends much more time going sideways or up than it spends going sharply down. The across the board thrashings are just a small sliver of the clock, which is why permabears, who continually just wait for these events, don't average good results over the years. If you're a stock picker, the market leaves your stocks alone the vast majority of the time.

Feb 04 08:22 PM

[Paul from C...:]

BrucePile,
What are you smoking? Are you trying to give people false hope? The market will be down 20% at the end relative to the beginning... no earnings, unemployment snowballing, increasing socialism, credit card crunch, etc. etc. I'm with Biderman and I'm shorting the market, buy SDS.

Feb 05 02:00 AM

[Moon Kil Woong:]

I think the market will recover when 1) the SEC does its job and susses out the muck, 2)when the market goes down when the government tries to dump more money into the system through bailouts or stimulus 3) When we close some of these bad banks and rid ourselves of the two terrible siblings of Uncle Sam (Fannie Mae and Freddie Mac) 4) When heads start rolling from bad companies and crooked behavior on wall Street 5) When we either re-enstate Glass Stegal, regulate derivatives especially ones betting on US $ defaults and CDS and CDOs, or get rid of allowing banks to hide losses off balance sheet (maybe doing all at once is too hard for the market to bear).

The market downturn is a intrinsic effect of poor regulation, corruption, bad economic policy, intrinsic deficit spending, and shoddy accounting. It is not just a issue of a housing bubble. That was just the last straw that broke the camel's back.

Feb 05 03:14 AM

[Doug Poretz:]

The concept of "recovery" includes the concept of "return." Maybe we should start considering that we aren't going to "return" at all, but move in a different direction that will have different characteristics and might even require different charts and different indicators. I think that is a very real possibility, especially as we move decidely in the direction of a Hegelian shift from capitalism to some version of something new, but probably not socialism as we have envisioned it. IF that is the case, will there be a "recovery" or a "return" to what existed previously? I think it might be better to start considering where the hell we are going versus how and when and why we will go back to something that may not be possible to return to in the first place. I will worry less, if and when the capitalists of the world stop applauding the quasi-nationalisation of critical components of our economy, and when politicians, while keeping a justifiable sense of urgency, stop just a moment to consider the legacy of their efforts to get something done immediately. Or does a Hegelian shift occur without thought at all?

Feb 05 09:05 AM

[mediapro:]

Huzzah!

And for the few who missed the details of bad economic policy, let's retrace a bit of the recent thirty year flirt with Friedmanomics:

Flash back to the neo-con's answer to 1970's stagflation and Milton Friedman's Shock Economics Theory he plied so well in South America for right wing fascists.

Roll tape a bit forward to the Gipper. Cut taxes, spend on defense out the wazoo, run record deficits, de-regulate markets and watch Uncle Milties' magic work.

While every right wing neo-con tape loop is buzzing with out-of-control GSEs, we all seem to conveniently ignore how all of this silly and frightening theoretical economic approach played out around the world through the likes of the IMF, World Bank, Halliburton, and their ilk.

Look at any country where this supply-side, trickle down, deregulated gambit has played and look at how eeiry is the similarity between those countries and this one:

1. The top 1% control 40% of all financial wealth in the U.S. The top 20% another 52%, leaving the rest of us (80%) America's financial wealth at a whopping 8%.

2. In terms of inherited wealth only 1.6% inherit more than $100,000. 91.9% receive nothing. Yet the "death tax" was/is the highest priority on the ultra-conservative agenda.

Now for some sobering reminders:

Under Clinton we enjoyed a $287 Billion SURPLUS that's now an ever-growing DEFICIT that at last peek was nearing $1.4 Trillion and national debt that has grown from $5.7 Trillion to $10.2 Trillion in just seven years.

It wasn't because Clinton was an economic genious. He simply returned out-of-control revenue reduction (tax cuts) back to the Reagan rates and chose folks who shared his philosophy of government and its role. I'll put my money in the hands of the guys that believe that it's the government's job to invest in the 80% of us that need practical ways to grow our own wealth (smart energy policy, infrastructure development, education).


On Feb 05 03:14 AM constructe wrote:

> I think the market will recover when 1) the SEC does its job and
> susses out the muck, 2)when the market goes down when the government
> tries to dump more money into the system through bailouts or stimulus
> 3) When we close some of these bad banks and rid ourselves of the
> two terrible siblings of Uncle Sam (Fannie Mae and Freddie Mac) 4)
> When heads start rolling from bad companies and crooked behavior
> on wall Street 5) When we either re-enstate Glass Stegal, regulate
> derivatives especially ones betting on US $ defaults and CDS and
> CDOs, or get rid of allowing banks to hide losses off balance sheet
> (maybe doing all at once is too hard for the market to bear).
>
> The market downturn is a intrinsic effect of poor regulation, corruption,
> bad economic policy, intrinsic deficit spending, and shoddy accounting.
> It is not just a issue of a housing bubble. That was just the last
> straw that broke the camel's back.

Feb 05 05:05 PM