Recovery Evidence Is Flimsy: Investors Beware

Anyone looking for thrills these days should forget roller coasters and skydiving. Instead, simply buy a few shares of U.S. stock. The past year has reminded us how truly stomach-churning the financial ride can be.

And after a white-knuckled drop in 2008, investors who held on are now enjoying a dizzying ascent. In the past five months alone, the S&P has risen by 22 percent and the NASDAQ by 33 percent. Emerging markets are back almost to their pre-recession levels. Even individual American stocks have performed in a stellar manner. Apple (AAPL), Cisco (CSCO) and Oracle (ORCL) have all risen by over 200 percent. Ford, an aging relic once given up for dead, has risen by 268 percent!

But what we have seen is more than just a lesson in physics. Stocks are not going up only because they previously went down. We are witnessing a return of hope. While the change is heartening, it is sadly based on the flimsiest of evidence.

The current rally has been sparked by some modestly good news: the Purchasing Managers’ Index is up, GDP has retracted by only 1 percent, and the fall in home values appears to be leveling off. Taken together, the appearance of these ‘green shoots’ has many, such as Larry Summers and Tim Geithner, convinced that the recession is over.

Somewhat more guarded than his colleagues within the Administration, Fed Chairman Ben Bernanke testified to Congress that he foresaw a “jobless recovery.” One is left to wonder how an economy burdened with double-digit unemployment can recover without new jobs. In recent decades, there have been some jobless recoveries from mild recessions, but they were built upon asset booms. Today, we face a very deep recession. The asset boom has collapsed. A jobless recovery in an economy based on 72 percent consumer spending is an oxymoron.

Unless our economy can go through a needed and painful reorganization, in which the industrial sector is revitalized, recovery from this recession will have to be based upon consumer demand. With unemployment increasing at over 500,000 workers a month, wages dropping, and hours worked declining, it is hard to see consumer demand rising convincingly enough to provide the engine for a rebound.

Meanwhile, U.S. Treasury debt is exploding, the U.S. dollar falling, and unemployment rising. In such circumstances, how can the stock market rise be trusted? What is the reality?

Added to this conundrum, credit remains tight, despite the injection into the banks of vast amounts of Fed funds at zero percent. And, for the first time, banks are being paid interest on the reserves required to be held at the Fed. Paradoxically, this hidden taxpayer boost to banks’ earnings is one of the prime reasons for tight credit. What bank would lend to corporations or individuals, incurring risk, when it can lend to the Fed – at considerable profit – without risk?

With the consumer still in shock and denied credit, why do some indicators appear positive?

The short answer for this is massive deficit and stimulus spending by the federal government. More than $3 trillion alone this year. That's nearly $10,000 for every citizen of this country. Little wonder that some consumers have ‘handout’ money to spend. And it’s no surprise that after a massive sell-off, certain retailers are refilling their inventories, causing the Purchasing Managers’ Index to rise. Likewise, now the threat of a banking collapse has passed, albeit temporarily, the rate of job cuts can be expected to fall.

Looking ahead, there is a $3.4 trillion commercial mortgage problem due to face the banks in September. This most sobering prospect, combined with the various pressures on consumers, would appear to indicate that the American economy is in the ‘eye’ of an economic hurricane. When jobs fail to materialize and credit remains frozen, look for corporate earnings to remain depressed. This reality can only be ignored for so long.

Any investor in U.S. stocks and bonds should be extremely wary, particularly as autumn may well herald a rise in interest rates and, as a result, another round of collapses. The ride up may have been fun. But remember last year before you dare to hold on for more.

Comments

[ron_paulite:]

good article.
the current rally is driven by greed and fear, i.e., fear of losing out
the buyers are anticipating the recovery.
or maybe hyperinflation? with money losing its value, maybe some think stocks are a better store of value?

Aug 06 04:06 AM

[Steven Hansen:]

except for GS, the financial world profit comes with book keeping smoke and mirrors. the corporate world with eating inventory.

we are going to have a bumpy ride until an economic driver becomes apparent other than the government.

Aug 06 04:19 AM

[User 353732:]

The economy faces 3 things which are real and sadly negative:
1. The income statements and balance sheets of 90% of Americans are still deteriorating; and with jobs being lost at astonishing levels and debt repayments coming due against weak or deteriorating collateral there is little prospect of income/net worth recovery for the next few (at least) quarters. Therefore, final consumer demand will probably fall again in the fourth quarter of 2009. To get a perspective, compare household/small business income statements and balance sheets in Aug 2009 with Aug 2008 and consider the magnitude of the implosion.
2. Solo, Small and Medium businesses, which generate a majority of jobs, face worsening credit availablity and higher all- in credit costs, so they have no ability to create net new jobs. Further, as forced starvation of credit continues for all but the politically favored (and low to negative value added )big companies as a matter of National policy, our engines of job creation are stalling further as survival strategies dictate more layoffs. Again compare the credit enviornment for solo, small and medium businesses in Aug 2009 with Aug 2008 for a perspective
3. Foreign markets for US goods and sevices continue to shrink so there is no possiblity of export driven growth even as oil prices stay high, further draining households and businesses of cash and discretionary income,

Investors , in addition to these 3 real things also face 3 big risks:
1. Bad Government that continues to grossly distort resource allocation in the economy by diverting resources from those who create value to those who destroy value, which is compressing not only current national income but more dangerously National wealth creating capacity ie future income. The single gretaest source of risk for investors is the Govt
2. Misleading and artificially boosted reported "profits" as big companies use one time, non replicable cost cuts to cope with recurring revenue declines
3. Govt induced class warfare that blames the productive Middle Class (the source of entrepreneurship and good innovation ) for the Nation's manifold and parallel problems ; further concentrates wealth and power in the tiny upper class; and encourages resentment, envy and a demand for increasing entitlements in the growing lower class.
Class warfare inevitably creates social instability and new risks while further eroding the confidence of the Middle Class and small/medium businesses. Fear, resentment, envy and concentration of econmic and political power never have and never can lead to high quality, sustained economic growth in a functioning democracy........the elites will ,of course, use this as an excuse for further collectivizing the economy and disenfranchising the Middle class in the name of the People

Aug 06 05:56 AM

[Matevski:]

"What bank would lend to corporations or individuals, incurring risk, when it can lend to the Fed – at considerable profit – without risk?"

Incredible. Truly incredible.

Aug 06 07:36 AM

[Matevski:]

"Looking ahead, there is a $3.4 trillion commercial mortgage problem due to face the banks in September."

This might be the one event that will put an definite end to the stock rally and then maybe, just maybe, the fools at ABC, FOX, CNBC etc will wake up and start questioning the Fed, the so-very-nice-and-kind Government and the banks.

Aug 06 07:43 AM

[ain't no fo...:]

This from Deutsche Bank via Reuters yesterday: "The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday."

Even if they miss by a small degree on that number, that is nevertheless a catastrophic number, especially since the worst of the current and future hits will be taken on prime and jumbo prime loans as this sucking chest wound just keeps taking bigger chunks out of the housing market.

Add to this the author's comments about the "pretend and extend ad infinitum" scheme of denial financing the banks are using to continue rolling over CRE loans under the frantic hope that CRE will recover before the repeatedly rolled over debt comes due, while vacancies and tenant bankruptcies soar, and the consumer continues to deleverage and his net worth continues to evaporate.

And still the "market" of one or two players tells us that banks must be on the mend... yet the industry refuses to mark trillions of $$ of existing toxic assets to market, and they continue to hold off residential mortgage and CRE loan foreclosures so that they don't have to markdown millions of existing assets representing a trillion or two more dollars of junk.

The absurd farce and government scam that was the bank "stress test" continues apace, nobody seems to recall at all that there were "most adverse" scenarios that are and will continue to be breached and the kool-aid continues skipping merrily past the graveyard.

There will be a day of reckoning. My fears are that it will be a violent day. One just needs to listen and participate in the conversations even here in rural Vermont to know that there are a lot of very angry middle class citizens who feel betrayed by this tragedy, and resentful, as an oligarchy totally out of touch with reality drives a stake in the heart of the American public.

Aug 06 09:29 AM

[enigmaman:]

In spite of it all the market defies gravity, this market is driven by the manipulation of investors emotional state of mind, its fear of missing the train as it leaves the station. Once skeptical institutional investors started boarding the train, they try to convince other skeptics its different this time because they need others to verify what they believe is true, so the market goes higher IMO I see that you cant fight the tape, when the worm turns institutions will provide the moral support so retail investors stay the course so they can quietly liquidate positions, I wonder if retail investors will be able to pull the plug when they need to, based on history it doesnt appear they can, because they want to believe what they have been told, we are on the mend and the future looks bright, because Its what we all want to hear and believe

Aug 06 10:14 AM

[enigmaman:]

The admin is definitely very much behind this manipulated market, provided the cash and the ability for select financials and corporations to prosper, while I am not against Gov intervention providing support to help the economy get on the mend I do have a problem with its complete about face as it relates to its feeling about greedy wall street and greedy corporations. As the market was imploding Pres Obama couldnt say enough bad things about wall street and corporations, only a few months ago there was a lynch mob attitude in DC and main street, bolstered by the Pres. Now we dont hear one word, no demonizing of the same by the Admin, no mobs in the streets, no protests of bonuses, GS posting record breaking profits only months after a near death experience, and then tey announce they will pay 11 billion in bonuses this year, not one word from Obama nothing, the silence is deafening. Obama has joined forces with the dark side, all are happy because people are making money, corp are posting profits and Obama needs the love so he bites his lip, closes his eyes and lets the deck become stacked against the retail investor. When the economy stalls again and the market falls he will be back up to his old trick and the money changers will not care because of the Cha Ching they hear in their pockets. Its a crime

Aug 06 01:20 PM

[ain't no fo...:]

Tell me about it. I voted for him. I've watched the metamorphosis with ever increasing disappointment. I feel like he's betrayed us by his silence toward the big banks while the middle class takes it squarely up the a$$.

I never trusted Summers, Geithner or Bernanke, but Mr. Obama I did trust. Did as in past tense. What the Hell happened Mr. Obama?


On Aug 06 01:20 PM enigmaman wrote:

> The admin is definitely very much behind this manipulated market... Its a crime

Aug 06 01:38 PM

[lynnybee:]

Thank you, Mr. Browne, for another great article. I always look forward to your articles, they educate me............. I'm such a novice to the economic scene, but, really enjoying it and learning so much. Sincerely .........

Aug 06 01:39 PM

[GotLife:]

ain't no,

I share your pain, sort of. I once voted for J Carter, architect of the Iranian revolution. Jimmy also designed the diplomatic solution of recurring billion dollar payments to Israel, Egypt, and the PLO (which they promptly use every year to grease the ruling class and buy arms.) His price controls were genius, leading to massive oil shortages. I doubt (sincerely pray) that nothing Obama or Congress does can be as idiotic as Jimmy. I recently watched a PBS special on his Presidency, usually full of spin for Presidents, and they completely, fully and even exponentially trashed the man.

Never trust a Politician. I don't even know how they sleep at night. Do you? Do you? Oh yeah, first they lie on one side and then they lie on the other.


On Aug 06 01:38 PM ain't no fortunate son wrote:

> Tell me about it. I voted for him. I've watched the metamorphosis
> with ever increasing disappointment. I feel like he's betrayed us
> by his silence toward the big banks while the middle class takes
> it squarely up the a$$.
>
> I never trusted Summers, Geithner or Bernanke, but Mr. Obama I did
> trust. Did as in past tense. What the Hell happened Mr. Obama?<br/>

Aug 06 07:43 PM

[perceptions...:]

A few applicable points, from a recent article -
Links -
www.eurointelligence.c...
www.eurointelligence.c...

"Ignorance more frequently begets confidence than does knowledge".
"Never in the history of the world has there been a situation so bad that the government can't make it worse."
"On 14 June 2009, Wolfgang Munchau writing in the Financial Times ("Optimism is not enough for a global recovery") eloquently summed up developments: "Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world."

Aug 06 09:02 PM

[ain't no fo...:]

Well, my comments weren't about Carter. They were about Obama. I am disappointed by the President's lack of toughness toward the banks that have basically held the country hostage with a gun to our heads while we hand over everything they demand, including hundreds of billions in TARP and FED money, allowing them to jack up credit card rates to "punish us" for passing a law designed to stop those self-same abuses, watching them hijack the financial markets with that TARP money, their use of dark pools, flash orders, SLP monopolies, and awarding themselves many billions of dollars of bonuses last year when the American taxpayer was the only thing that saved their effin butts.

My support of Obama's healthcare reform program stands.

My support of a public option for his health insurance stands even more... it is the only way we will ever get fair competition.

Many politicians are vain, lying, cheating, backstabbing fools who have sold out to the lobbyists. But there are some good ones, and one I would personally commend for being an excellent PUBLIC servant who has conducted himself with decency, honesty and good grace is Sen. Pat Leahy of VT, where I live part of the year. He is a good man, and that is high praise from me... the highest it gets.


On Aug 06 07:43 PM GotLife wrote:

> ain't no,
>
> I share your pain, sort of. I once voted for J Carter, architect
> of the Iranian revolution. Jimmy also designed the diplomatic solution
> of recurring billion dollar payments to Israel, Egypt, and the PLO
> (which they promptly use every year to grease the ruling class and
> buy arms.) His price controls were genius, leading to massive oil
> shortages. I doubt (sincerely pray) that nothing Obama or Congress
> does can be as idiotic as Jimmy. I recently watched a PBS special
> on his Presidency, usually full of spin for Presidents, and they
> completely, fully and even exponentially trashed the man.
>
> Never trust a Politician. I don't even know how they sleep at night.
> Do you? Do you? Oh yeah, first they lie on one side and then they
> lie on the other.

Aug 06 09:27 PM

[TCK:]

With a name like MIT Economics I would think that you could do better than post the same simple comment on every news story on Seeking Alpha !




On Aug 06 07:02 PM MIT economics wrote:

> Why does the market keep going up every month? Because 'less bad'
> is the new good.
>
> hat tip to www.iamned.com

Aug 07 05:13 AM