Promising Signs for the Economy and the Equity Markets

We try to identify and monitor the best sources and indicators. This is extremely important. Without a disciplined approach, the average person gravitates to sources and evidence supporting his/her current viewpoint -- the confirmation bias.

In a time when most of the economic news is grim, it is especially important to seek out leading indicators. It is equally important to recognize data related to the long-term economic challenges.

The Recession Might be Over. So says the Economic Cycle Resesarch Institute (ECRI), long one of our favored sources, and accurate on the start of the current recession. One might contrast the ECRI prediction with assorted pundits who predicted a recession for years before it occurred.

Writing for RealMoney (subscription required, trial available) Anirvan Banerji reports that the ECRI leading indicators are showing significant strength.

What's impressive here is the degree of unanimity within and across these leading indices, along with the classic sequence of advances in those indices. Such a combination of upturns doesn't happen unless an end to the recession is imminent.

Why are so many getting this wrong?

...(I)ndicators are typically judged by their freshness, not their foresight. Because most market-moving numbers are coincident to short leading, while corporate guidance is often lagging, it's no surprise that analysts don't discern any convincing evidence of an economic upturn.

Regular readers know that we are long-time critics of looking to corporate guidance, a concurrent indicator. The companies are reading the same newspapers as everyone else, and they have little current incentive to puff up expectations.

Please note: The end of the recession does not necessarily mean imminent happy days. There will be a period of below trend growth. This means economic under performance and high unemployment. Banerji specifically refutes the idea that high unemployment will derail the recovery.

Fed Balance Sheet. Many are worried about the Fed balance sheet, a topic we recently covered. Supporting the evidence that there is a definite "exit strategy" is the Atlanta Fed's Macroblog, one of our featured sources. David Altig goes right to the Fed minutes to support his argument. This is strong evidence for any objective observer.

Earnings are Surprisingly Solid. Many critics observe that companies are beating expectations by controlling costs, not by growing revenue. We expect the revenue growth comparisons to look very good in the latter part of the year. The key economic losses came after the Lehman failure. Meanwhile, companies that got lean and mean are poised to deliver good gains as fiscal and monetary stimulus has its full effect. Employment will lag.

Remaining Problems

There are continuing issues in credit markets and housing. As we wrote in April, there will be a "wall of worry". For the individual investor, this means that progress will be gradual and grudging. This summer is an important time to think about asset allocation, especially for long-term investors.

Most investors will get this wrong, trailing the market by an annualized rate of 6.5%. Check out Toro's article, "You are Probably Bad at Investing" for some good evidence on this point. It confirms every story we have seen over many years on this subject.

Comments

[Schweizer:]

The last recession officially ended in Nov 2001, however the market continued down for 16 more months shedding almost another 40%. Unemployment continued to rise and peaked right when the market made a confirmed bottom in 2003.

Investing in equities as a recession ends and positive/flat GDP is reported is a sure way to lose more money.

Here's a chart. Don't expect to see CNBS to show such facts:
social.stocktock.com/p...

There will be another huge leg down in equities just like there was in 2002 right after the government data showed things had bottomed in the economy.

Bear market bottoms are made with a GAAP PE of under 10. It is currently 31 using the latest 2009 actuals and forecast for GAAP earnings for the SP500 ($29.98 as of 7/17/2009).

In the past, earnings stayed relatively flat during the period but prices fell to reach this PE<10 level. I expect this is happen this time too.

Jul 19 06:50 AM

[enigmaman:]

I look at the way the market has preformed since 1930, based on ten year increments, the only times their is any correlation is 1930-1940 and 2000 to present time, these are the only times the market was down for ten years, 1930-1940,-45%, 2000 -present, -20%
Hard for me to see anything coming close to business as usual for our economy as far as GDP, corp earnings, growth rates, financing growth, consumer sentiment. Companies cant get smaller fast enough, there is no way they will grow themselves anytime soon no matter what, that has to affect everything going forward, a recent Met Life survey metlife.com/dream
indicates we are entering a completely different economic phase, a New Normal so to speak, so using past recessions to predict the future just doesnt hold up, how anyone can say otherwise is beyond me. ECRI reports we are coming out of this recession but what they do not say is what the economy will look like when it does. Seems to me there is another show to drop that will undercut the market, probably abruptly so investors will get caught in the meat grinder yet again, should this happen I would expect investors to crawl under their beds to hide and wont come out for many many many years, only so much pain anyone can take

Jul 19 09:02 AM

[LR European:]

Excellent, well balanced article. Thank you.

Jul 19 10:15 AM

[Dean Morel:]

Jeff, as always you're both informative and interesting to read. Your open minded approach is a shining light to all and a great contrast to people who say things like "There will be another huge leg down in equities". Will there indeed. It could happen, but certainty is something best left to marriage and kept well away from equity markets.
I rightly stand accused of confirmation bias ;-)

Jul 19 07:59 PM

[Dean Morel:]

Schweizer, that is a good chart you linked to. Have you done the same for other recessions? I know I'm guilty of parroting that the stock market is forward looking and turns up 6-9 months ahead of the economy, so it would be fantastic to see more than one data point.

I agree a PE level of around 10 could be reached, but that could be in 2014 or later. Are you going to sidelines until then?

Jul 19 08:16 PM