WEEKLY ECONOMIC ANALYSIS: April 3rd, 2009

Provided by TEAM Financial Services

"Who would have thought that the people managing the Denver Broncos would make the US Congress look competent in comparison?"
- James Dailey

Items for Discussion

By all accounts, the economy came to a dead stop in October and November of last year. This seizure in economic activity had a lasting impact, but the major question is whether it was a window into what is to come or a temporary phenomenon. As TEAM chronicled at the time, ECRI’s weekly leading index began to stabilize in December and has since recovered modestly in the last couple of months. This accurately predicted the marginal uptick in various economic statistics in recent weeks. Such an uptick is not unusual or unexpected following the massive shut down in the economy last fall. For example, retail sales have stabilized in recent weeks following the significant drop late last year. This makes sense, as people deferred purchases due to the acute nature of the economic anxiety. Over time, people begin to acclimate to the environment and recalibrate their financial situation. The trends in retail continue to indicate that consumers are very nervous, as purchasing patterns remain tilted towards discount retailers and generic over brands. 

At this point, TEAM believes that the uptick in the recent economic statistics is a “dead cat bounce”. We simply do not yet see enough evidence that a sustainable recovery is going to emerge over the next 6 months. This is an important variable to consider, as the recent 25% rally in the US stock market off the March 6th low is not likely to emerge into a more enduring cyclical bull market unless some sort of economic recovery develops. In addition, the market reached our first target for the rally off the March 6th low, so even if a more extended bear market rally is to occur, we would expect the market to at least be choppy for a week or two. It is also possible that the market could rotate lower to consolidate some of the recent gains prior to heading back up to test the January 2009 high – around 940 on the S&P 500. 

The following chart, courtesy of Sentimentrader.com - a site to which we subscribe, shows market rebounds off of the major market lows since 1935.



As one can see, the dark black line is the current rebound through the end of March. The rally over the past couple of days brings the S&P 500 right up to the +25% area. Each of the 6 historical market lows suffered through a retracement of the initial bounce of 50%-75%. Such a retracement would result in the S&P 500 moving back down to the 755 to 710 level on the S&P 500. This would result in a 10%-15% decline in value from the high of about 845 hit yesterday.

Ironically, if the market is forming a cyclical low, then the kind of retracement I just explained would be a healthy and positive development, in our opinion. However, if the market takes only a relatively brief breather to consolidate the recent rally before exploding above this week’s high, then that would be much more indicative of a major bear market rally developing. So what is the difference? The big difference would be in the likely duration and size of a market move. A cyclical recovery would likely require more time to form a strong base on which to build a more sustained and larger market move higher over 6 to 18 month in duration. A large bear market rally (in the 40%+ range off the March low), would likely consolidate recent gains very quickly prior to completing its move over a 1 to 3 month period.

A third and far more ominous potential outcome would be that the bear market rally peaked this week and the market is poised to roll over and fall to new lows. At this point, TEAM does not have enough information to make a forecast we have any confidence in, so it will be critical to monitor how markets behave in the next couple of weeks. Tactically, we are looking to reduce portfolio risk on the margins until we get a better sense of the market’s likely path.

Market/Economic Climate 

While we don’t have any definitive signs that a cyclical low is in place, we do have an encouraging first sign for optimism. ECRI’s combination of leading indicators is now forecasting that “an upturn in the US growth rate cycle is now in clear sight”. As TEAM has been communicating since December, the first step towards a potential economic recovery is stabilization. The second step is for the growth rate of the economy to shift back to positive. What does this mean in English? If the economy has been contracting at a 6% annualized rate recently, stabilizing at that rate of decline is the first step – versus accelerating to minus 8% for instance. The second step is to have the growth rate shift positive, which would have the decline fall to 4%, for instance. The last step would be an indication that a full blown economic recovery is in the cards, in which case growth would be expected to turn positive. 

Therefore, we now have two of the three steps occurring. At this point, our best guess is that this is enough to at least result in a larger bear market rally than what we’ve enjoyed to date. If the third and final step becomes evident in the coming weeks, then a cyclical recovery may be in the offing. TEAM remains skeptical about the potential for a significant cyclical recovery due to some pending issues in the housing/mortgage market. Clients will receive a more detailed analysis of this when quarterly statements are mailed around the middle of April.

Humor for the Weekend

This graphic comes via the Big Picture Blog authored by Barry Ritholtz.

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.