The Markets Seem To Like The Gloomy Economy

The Dow ended the day up 190 points while the S&P rose 24 points. It sure wasn't because of the stellar economic news. Afterall, GDP dropped .3%; consumer spending declined 3.1%, the first decline in 17 years and the biggest falloff in 28 years; and inflation-adjusted after tax income fell 8.7%. The other good economic news was initial jobless claims were steady at 479,000 while spending on durable goods plunged 14.1% and non-durable goods fell 64%, the lowest in 58 years. At this pace, the DOW will skyrocket another couple of thousand points.

Companies continued to report weaker expectations for the next quarter and dispalyed plenty of uncertainty in their business outlooks for next year. The fourth quarter promises to be much worse than the third quarter as layoffs seem to be picking up steam with American Express and Goldman Sachs both making cuts up to 10% of their workforces. This trend will continue right into the new year as spending is slowing by the consumer and the holiday season will be a disaster.

The real estate market continues to see a drop in home prices. Even The Hamptons, an affluent community on Long Island, is seeing 18% declines. As Wall Street bonuses are cut this year and people tally up their diminished net worths, spending will continue to fall. 2009 promises to bring on new focuses for financial institutions as the consumer default rates on credit cards, auto loans, student loans, and home equity loans start to ratchet up. We haven't even addressed the continued fallout from the credit default swap market, the weakening commercial real estate market, and the huge downsizing of the auto industry. The expectations for next year only seem to be gloomy.

At least interest rates are almost at zero. Once they reach that level, the Federal Reserve can turn their full attention to the impending inflation in the next few years but first they need to deal with the near-term deflation problem.

The economic news is horrific yet the markets have risen a lot this week. Markets always anticipate the turnaround in the economy and rise well before it bottoms. Are we now at that point? We still believe October 10th may have been the bottom of the market but we are likely having a bear market trap right now. Stocks are rising and could move up another 5-10% but they won't go straight up. When we listen to earnings calls it is obvious that most companies are retrenching. This will likely cause the economy to get much weaker and drag out the recession for a while. The stock market may be in a bottoming phase but this recent rally will at some point come back down to earth. Markets usually lore investors in before they shake them out. This weekend the papers will likely be talking about the next bull market. Nobody wants to miss the next big climb in stocks. People will start to buy again and just as this new bear rally peaks, everybody will feel good again. That is when it will once again be "All About The Economy".

The market will have a sustained rally at some point and we will have another bull market. It just isn't ready yet. If you need to chase the rally, continue to buy quality but be careful. The economy is going to be bumpy for a while and before the stock market can go on its next big run, it will need to come down first. This could be a a few month process and the ride could cause nausea so be cautious.