The Recession Has Ended! Has The Bull Market Also?

October 30, 2009

The Great Recession has ended. Halleluiah! It was the worst recession in many ways since the Great D. Just imagine. After four straight negative quarters the economy recovered in the third quarter. Not only did it recover, but GDP rose 3.5% in the third quarter, even more than the consensus forecast of a gain of 3.2%.

The relief is so great you can . . . . well, you can hardly detect it.

The stock market loved it – for about seven hours, with the Dow closing up 200 points on Thursday after the report was released. The market certainly deserved a day of celebrating that it had been right in anticipating the end of the recession by rallying all summer.

However, the market began declining ten days ago, as the GDP report time approached. And after only a one-day rally to celebrate the report, it turned back down with a vengeance the next day.

Was it a classic example of buying on the rumor and selling on the news, or perhaps of reality setting in?

Some quite savvy analysts began warning in May that the rally was getting well ahead of reality in its excitement, factoring into prices not only that the recession was bottoming, but that the recovery is going to be spectacular.

There have been warning signs lately, with economic reports coming out over the last month indicating the recovery might instead be problematic.

Even a peak behind the curtain to see how the GDP growth in the third quarter was achieved raises questions about the sustainability of the improvement, casting doubt on whether it can flow over into coming quarters, or even the current quarter.

For instance, consumer spending rose 3.4% in the third quarter, providing a good part of the improvement in GDP (gross domestic product). That was terrific since consumer spending accounts for 70% of the nation’s economy, and the economy can hardly be expected to recover without a big improvement in consumer spending. Unfortunately, the 3.4% increase in spending was accompanied by a 3.4% decrease in consumer income, not a sustainable situation.

The extra spending also showed up mostly in sales of big-ticket items like houses and autos, which produced a rebound in home-building, and auto manufacturing. However, we all know the catalyst for much of that spending was not normal, but due to the government’s ‘cash for clunkers’ program, and bonuses to first-time home-buyers.

Indeed, the bottom literally dropped out of auto sales once the ‘cash for clunkers’ program ended.

And unfortunately it was reported on Wednesday that new home sales declined 3.6% in September, even though the bonus for first-time home-buyers was still in effect. That was versus the consensus forecast that new home sales would rise 5% in September, and came on the back of the previous week’s report that ‘existing’ home sales fell 2.7% in August, the first decline since March, and the report that permits for future single-family home ‘starts’ fell 3% in September.

Third quarter GDP also got a boost from inventory building. Businesses had allowed inventories to drop at a record pace during the worst of the recession last winter, and began replenishing their shelves in the third quarter, encouraged by improving consumer confidence and rising retail sales. But that increased economic activity will not continue if the replacement goods don’t move off the shelves any faster than they have for most of the year. Whether they will or not will depend to a great extent on consumer confidence.

Unfortunately, the latest reports on consumer confidence are not encouraging either.

The Conference Board reported this week that its Consumer Confidence Index fell to 47.7 in October from 53.4 in September. On Friday Reuters/University of Michigan reported their Consumer Sentiment Index fell to 70.6 in October from 73.5 in September. The majority of consumers in the poll also reported that their financial condition had worsened in October for the thirteenth straight month, the longest decline in the history of the survey. It shouldn’t be a surprise, given the staggering number of people who have lost their jobs, and the surprising percentage of homes that are no longer worth as much as their owners owe on them.

What consumer confidence does not need right now is another substantial decline in the stock market, mutual funds, 401K plans, and IRA’s.

But in spite of the GDP report, or perhaps because of it, the market has returned to the decline that got underway a couple of weeks ago. Its focus is now on further down the road, which means wondering if the Q3 economic improvement is sustainable.

The important report in that regard may be the Labor Department’s employment report for October, next Friday, and whether it will show fewer job losses than recent reports.

Meanwhile, I hope the market can avoid a panic while waiting.

Short-term traders, including the big-program trading firms continue to dominate the market. When they reverse from selling into rallies to buying the dips, as they did in early March, it can make for an exciting and explosive upside reversal. But if they reverse again, from buying the dips, to selling into the rally attempts it can lead to panic, especially after an unusually large rally has investors confident that they will see only higher prices, and are unprepared for something different.