L-Shaped Recovery? Short Term Bulls Heading for Trouble

by: TraderRob

As U.S. equity markets have rallied from the recent bottom on March 9, 2009 the S&P 500 index has gained 23% to the market close on Thursday April 02, 2009. Take a moment and recount the year end 2008 "doomsday" forecasts for an "L shaped" recovery, which suggested that the U.S. economy would not recover from the severe job losses, profit destruction and deleveraging process in an immediate or vigorous fashion. Presently, only the "bearish" of the bears are holding true to this theory. Whether investors cite stimulus efforts, over done pessimism or an intuitous market, the masses seem to subscribe to a quite opposite outlook.

It would seem that a "V shaped" recovery now dominates the consensus as market movers brushed off the BLS (Bureau of Labor Statistics) report of accelerated job losses of 663,000 jobs. Investors also overcame an unfortunate decline in the ISM Non-Manufacturing index reporting the March level below the 32.0 consensus and the 41.6 February level at 40.8. For investors with a two to three year time horizon for their investments, a market overcoming bad news is very positive for sentiment.

This rally has been so violent to the upside that it could nearly be characterized as a mini bubble, first spawned by intense short covering. The continued appreciation of equities being witnessed at 800+ levels of the S&P 500 is the result of actual money coming off the sidelines as a new group of market participants are testing the water. The hot breath of stakeholders is still wet on the necks of pension funds and financial advisers who "sat idly" as endowments and retirement accounts were cut in half by the end of 2008, prompting decision makers to avoid disappointing twice by missing the "opportunity of a lifetime" bull market.

It is horrific to suggest that these same fiduciaries who missed the bottom are now buying the top of an overbought rally, but those who are late to the party usually find a soggy melted crate of ice cream and the dog eating the cake.

The froth of cases being made for a rally extension cite everything besides real economic data. "Employment is a trailing indicator and rose during the end of other recessions", "markets are more intuitous than investors and traders" and "the stimulus is going to create the jobs we need" are some of the most common. I don't fundamentally disagree with any of these points but correlation does not mean causation. It is crucial to be attuned to irrational human tendencies that spur the few people currently making money to suggest they will not continue to prosper.

Note that the trend in job destruction has shifted from blue to white collar jobs, where 279,000 jobs in the professional and business services sector were lost in March. This is the largest decline yet, and will support the transition from low to high value mortgage defaults. Also important to the Friday Employment report is the revised January total, adding an additional 86,000 lost jobs and foreshadowing adjustments to current data in the future.

Jobs are trailing indicators of economic recoveries eventually. For now focus on the bloated oil inventories and declining trends in real GDP, low factory orders, poor sales of goods and services, falling home prices, consumer confidence, and most importantly the coming earnings and outlook from actual U.S. firms.

The recession isn't over. Short term bulls are heading to the stock yard.
Disclosure: No positions