When I Think the Economy Will Pick up

by George Leong, B. Comm.

Following the recent breakout, the major stock indices are stalling due to uncertainties and a technically overbought condition in stocks. In my view, there is still a sense that the economy may not really pick up until sometime in the first half of 2010, if the stimulus works. In the meantime and over the summer months, stocks may trade sideways. As long as the breakout levels hold, there is a chance for another rally.

Technology has been the market driver this year, but in order for the broader markets to trend higher, there must be stability in the banking sector. The government is set to announce which of the country’s banks will be able to repay the TARP loans. The reason why this is important is that repayment reflects improvement in the banks and means less chance of nationalization, as the government’s ownership in banks falls. The reality is that the banking sector will continue to be a key in leading the economy forward. We need to see stability return to the credit markets in order for confidence to return to the U.S. economy.

Another key area that will also need to improve is the housing market. We have seen some encouraging signs over the recent few months, but the overall condition of the sector remains fragile. The federal government predicts that the price of homes will continue to decline in 2010 and this cannot be good for consumer spending and the economy. There also remains an issue, with many homeowners carrying mortgages that are in excess of the value of their homes. Homeowners may try to carry the mortgages, but eventually there is the chance of foreclosure, which has been the key factor in driving up the sales of resale homes in the recent months.

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On Monday, the Obama administration said it hoped to create some 600,000 jobs from the stimulus program. This would help, but unless we see a pick-up in economic activity and declining job losses, the weak labor market will continue to hinder the recovery. The May jobs report saw fewer jobs cuts than the previous months, but again we need to see a trend develop. When people are confident about their jobs, they will eventually begin to spend more and this will boost the economy.

Watch for the Retail Sales report on Thursday. The preliminary data did not look good and I expect more weakness in this report. Again buying will continue to be largely driven by the condition of housing and jobs market. We need to see improvement in those areas for spending to rise.

The positive is that stocks are holding and traders are more confident. Yet, for the rally to continue, we need to see more improvement in the economy, not only in the U.S., but also in other major world economies. There was some positive news after the Organisation for Economic Cooperation and Development reported on Monday its prediction that the global economic crisis may be easing, but also warned that it may be premature. For the U.S. to recover, we need to see increased demand from other major economies.