Is The Window Closing On A V Shaped Recovery

Despite the leading indicator of stock performance projecting an imminent economic recovery, several factors may undermine the “V” shaped recovery that many analysts are predicting. The two major …

Despite the leading indicator of stock performance projecting an imminent economic recovery, several factors may undermine the “V” shaped recovery that many analysts are predicting. The two major thorns in the side of the economy are unemployment and consumer confidence, which may be shrinking the window of opportunity for a strong economic recovery. For more on this, see the following article by Money Morning.

The U.S. stock market has staged one of the more impressive rallies in history this year, as “green shoots” of economic growth whetted investors appetite for risk. The Dow Jones Industrial Average is up more than 40% from mid-March, while the Standard & Poor’s 500 Index has soared 46% and the Nasdaq Composite Index rocketed an astonishing 55%.

Despite investors’ newfound optimism, the economy is still contracting, unemployment is still rising and consumer spending and sentiment is still abating. That could mean the sharp “V-shaped” recovery many analysts are anticipating may turn out to be a more-prolonged “U-shaped” rebound.

“We’re looking at a U-shaped recovery, which means getting off the bottom is going to be a lot more difficult than people are anticipating in the market,” Doug Roberts, chief investment strategist at Channel Capital Research, said in a Reuters interview.

Indeed, a bullish equities market means little to still-employed consumers who can’t be certain that they’ll still have a job next week. And since consumers account for as much as 70% of the U.S. economy’s output, the threat of unemployment poses a major risk to any recovery.

Why Unemployment Could Undermine a Recovery

The national unemployment rate hit 9.5% in June and analysts say it could easily surpass 10% by yearend. Statistics from the Labor Department today (Friday) are expected to show that roughly 328,000 jobs were shed in July, according to a Bloomberg survey.

Payroll firm Automatic Data Processing (Nasdaq: ADP) said earlier this week that job cuts are slowing, but that’s mainly because there are fewer people left to fire. ADP’s National Employment Report showed that non-government employers cut 371,000 jobs last month, compared to a revised 463,000 in June.

The ADP data “suggest the unemployment rate continues to rocket and household cash flows continue to fall,” Ian Shepherdson, an economist for High Frequency Economics, told The Washington Post. “Not a great outlook for spending, we’d say.”

Piling on the shrinking employment news was outplacement consulting firm Challenger, Gray & Christmas Inc., which said layoff plans in the United States ballooned 31% in July, compared to June’s 15-month low.

“We are still a long way from a full recovery,” said Chief Executive Officer John A. Challenger.

Lastly, employment activity as measured by the Institute for Supply Management (ISM) was equally dismal, as the index contracted for the 18th time in last 19 months.

The ISM’s employment index for non-manufacturing jobs – that is, service jobs like retail work, health care, and public administration – shrunk to 41.5% in July, down from 43.4% in the previous month. Any percentage on the index below 50% represents contraction.

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Comments from respondents in the ISM’s survey included “Continued attrition and layoffs due to economic conditions,” and “Hiring freeze in place, and we are unable to fill open positions.”

Since the recession began in December 2007, more than 6.5 million jobs have been lost and most economists now have the unemployment rate bottoming out at or slightly above 10%. Economists in the Bloomberg survey expect July’s rate to be 9.6%, meaning there’s still some more job erosion left before any turnaround occurs.

Crisis of Confidence

In addition to taking money directly out of consumers’ pockets, soaring unemployment has an adverse affect on those fortunate enough to keep their jobs, as well. Fearful that their job will be next, wary consumers lose confidence and save more.

And the two leading indicators of U.S. consumer sentiment – the Reuters/University of Michigan index of consumer sentiment and the Conference Board’s confidence index –show that consumers are not yet ready to return to the level of extravagance that helped keep the economy humming before last year’s financial meltdown.

The Reuters/UM index dropped to 66 in June from 70.8 the month before, and a preliminary report for July shows further erosion to 64.6, Bloomberg reported. The Conference Board’s index fell to 46.6 in July, down from June’s 49.3.

Consumers who are looking over their shoulders at work are much less likely to spend beyond the bare necessities. Discretionary spending is down, as evidenced by the 31% drop in June sales for the video game industry, once thought of as recession-proof. Discount retailers such as Wal-Mart Stores Inc. (NYSE: WMT) and Dollar Tree Inc. (Nasdaq: DLTR) are prospering in the weak economic environment.

Equally troubling is the fact that the consumer spending that has been strong is largely the result of government incentives.

A 3.6% boost in the National Association of Realtors’ (NAR) pending home sales index in June represented the fifth consecutive month of gains, thanks in part to the $8,000 tax credit for first-time buyers that is part of the $787 billion stimulus package passed in February.

The opportunity for consumers to take advantage of the credit is good until Nov. 30, but Senate Majority Leader Harry Reid, D-Nev., told Nevada reporters in a conference call that an extension of the bipartisan-backed program is likely, the Las Vegas Sun reported.

Then there’s the popular Car Allowance Rebate System (CARS), also known as “cash for clunkers.” The government’s $1 billion program paid consumers $3,500 to $4,500 to trade in their older, less fuel-efficient vehicles in for an automobile with a combined fuel economy of at least 22 miles per gallon.

CARS was expected to last until November, but once claims started to be processed on July 24, the program was on fumes within a week. At the urging of U.S. President Barack Obama, legislators in the House approved an additional $2 billion of funding for the program and the Senate is expected to do the same.

Should CARS get the expected additional funding, the combination of it with year-end model clearance markdowns could make for a relatively next few months of consumers snapping up new automobiles.

Still, the government can’t prop up spending forever, and with the national deficit expected to equal 13% of gross domestic product (GDP) in 2009 and 10% of GDP in 2010, another stimulus package will be a tough sell.

Indeed, the American consumer is far from out of the woods, and any economic recovery will likely be long and painful.

“The consumer isn’t going to be a leader in this recovery,” Nigel Gault, chief U.S. economist at IHS Global Insight, told Bloomberg. “Consumers are aware that the labor market is still pretty bleak. Any recovery in consumer spending will be very, very modest.”

The Flip Side

There are two factors that hint at a more-upbeat outcome for the U.S. economy: The stock-market-rally itself, and so-called “first-time jobless claims.”

Many of the indicators from recent reports are known as “lagging indicators,” because they are snapshots of the past. That’s true of unemployment, retail sales, GDP and others. But the stock market is “forward-looking,” meaning it tends to factor in expectations about future corporate earnings, income growth, inflation, unemployment and economic output. The unprecedented rally in U.S. stock prices hints at much better times to come.

The second factor is first-time jobless claims.

Since peaking in April, the four-week moving average of initial jobless claims has dropped more than 15%. That’s actually a bigger decline in jobless claims during a recession than in any of the other six economic downturns recorded since 1969, said a research report released a week ago by Bespoke Investment Group LLC.

“For the last couple of weeks, we have been highlighting how the recent trends in initial jobless claims suggest that the recession is over or winding down,” Bespoke wrote in a new research report. “However, there remains a considerable amount of skepticism towards the market’s rally. Critics contend that any meaningful rally cannot occur until the economy improves. With jobless claims still at high levels, they claim we have not reached that point.”

But jobless statistics say differently. Since peaking in April, the four-week moving average of initial jobless claims has dropped more than 15%. That’s actually a bigger decline in jobless claims during a recession than in any of the other six economic downturns recorded since 1969.

In other words, in the other downturns, Bespoke measured the percentage decline in the four-week moving average of initial jobless claims from their peak until the recession officially ended. That hints strongly that the current recession is over – or at the very least is at or near its end, Bespoke said.
That picture only got brighter yesterday (Thursday).

The Labor Department said first-time filings for state unemployment benefits declined by 38,000 to a seasonally adjusted 550,000 last week.

Economists surveyed by MarketWatch.com had expected initial claims to fall much less, to around 580,000. And the four-week average of new claims dropped to 555,250 – the lowest level since January.

Compared with a year earlier, initial claims were up 22%, while continuing claims were up 89%. Compared with six months ago, initial claims have fallen 12% while continuing claims are up 33%.

In an interview on cable-TV channel CNBC early yesterday, one trader looked at the first-time-jobless claims numbers and concluded: “The recession’s over.”

This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.

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