Economic Recovery: How Are We Doing?

by George Leong, B. Comm.

Markets started the week on a sour note, as it looks to extend the six-week rally from the March low. But we could see a pause as markets hit upper resistance levels. Despite the current uptrend, there remain issues that need to be resolve before stocks can trend higher. There are some pundits that believe the current recovery will be a “V” shape, which we are seeing in the price charts of the major stock indices.

We are not convinced and suggest that, based on the current economic data along with continued problems in housing and consumer spending, the recovery may more likely be a “W” pattern. Under this scenario, stocks could stage another decline to the lows and then follow this with a sustainable market and economy rally. Of course, the question is: when will the second leg up occur? Based on the current data, it could precede the economic recovery that may not happen until later this year or in 2009. Goldman Sachs predicts that the U.S. economy will expand by about 1.9% in 2009 and just over 2.0% in 2010. While this indicates growth, the numbers are not that impressive. We could see the U.S. economy lag for several years in the worst-case scenario.

In the financial sector, banks have been reporting some decent earnings, yet there are increased concerns regarding the condition of the balance sheets of the banks, namely the toxic assets that the government is trying to find buyers for. The Bank of America Corporation (NYSE/BAC) reported profits on Monday, but was a rise in the company’s loss provisions to a whopping $13.4 billion — and this could rise. The banks have been surging in the previous weeks and providing some leadership to the broader market, but the fact that there are toxic assets on the balance sheets is a concern.

Famed investor Jim Rogers is concerned about the rally in the stock markets and questions its sustainability. Markets remain at a crux and need to break higher or we could see sideways trading in the immediate future. The NASDAQ is continuing to show a bullish V pattern, but could not hold above a key point at around 1,650. Failure could see a relapse and a return to the sideways channel. The DOW is back below 8,000. The Russell 2000 is also around a key resistance level at 475. The other key major indices are also showing a bullish V pattern, but will also need to make some upside breaks (DOW: 8,400; S&P 500: 900-950).

Investor sentiment continues to show signs of improvement and this is positive for stocks. The NYSE has been bullish for seven straight sessions to Monday, while the NASDAQ has been in four of the past seven sessions. These numbers are encouraging, but they are far from being a sustained trend, which is what we want to see before there is any hope for a sustainable rally.

As I have said, the earnings and especially guidance will go a long way in dictating how markets trade over the next few months. We continue to see warnings from major companies of further corporate slowing or a lack of visibility going forward, which is a nice way of saying they have no clue what to expect.