Buying Time

The rally continues, mirroring (inversely) the relentless sell off that dominated January and February.  The S&P500 ended the week up 5.9% defying quite a few skeptics who don’t trust this move.  Some of the most troubled sectors (financial and retail) led the way; whereas many of the most fundamentally solid groups lagged (tech and consumer staples).

Economic fundamentals did not impress.  Sure the number of pending home sales improved (as it always does in the spring); and ISM services went up to 43.7, but still well below the 50 level signalling neutrality.  Inital claims stayed above 600,000.  Continuing claims jumped to 6.35 million (a 14th consecutive record).  Consumer credit (the fuel behind consumer spending) dropped much more than expected.  The unemployment rate rose to 8.9%, the highest since 1983.  And officially, 539,000 jobs were lost in April.  Unofficially, when  72,000 of obviously temporary Census workers are deleted and 60,000 of statistical add-backs are deleted, the real number of jobs lost was closer to 670,000.

Technically, the market jump last week looked like a blowoff top formation on the daily charts.  Prices clearly went up, but the force of the move was weakening and volumes were tapering off.  This is a negative divergence that resembles, very closely, the patterns formed in July 2007 and October 2007.  On a monthly basis, the bear market is still alive.

The key selling point, and it truly has been a sell job, is that the economy’s rate of decline is slowing.  This is the simple logic behind the green shoots and glimmer of hope messages put out by the Obama administration and the Federal Reserve.  What Mr. Geithner and Mr. Bernanke want the masses to do is believe that things are getting better.  Why?  To buy time.

If the public’s mood improves, if our collective animal spirits become more optimistic, then theoretically consumers might increase their spending and businesses might increase their hiring.  This would hopefully break the current negative feedback loop in which the opposite is happening:  consumers cutting back on their spending and businesses cutting back on their payrolls.

At the same time, the less valuable assets in our economy (real and financial) would have a greater chance of reversing their own price drops.  In other words, real estate, stocks, bonds and other securities might stop falling–this would stop the vicious cycle of collateral falling causing credit to contract, which leads to more collateral price reductions.

But the true measure of recovery, is not a slower rate of decline in the economy, but rather, an actual increase:  in consumer spending, in business investment, in real estate prices, in employment, in capacity utilization.   Green shoots won’t matter if the plants never blossom.

But what if the economy doesn’t turn this critical corner?  What if it continues to decline, in a more gradual, slow motion kind of way?

If the economy doesn’t show positive data, and soon, then the entire buying time gambit may fail.  Mark Zandi, a leading economist from Moody’s (and a Democrat) stated this week in the New York Times “The moment of truth is coming soon….If we don’t see something real in the data by June, then I get very nervous.”

June is only weeks away.  Perhaps we should be getting nervous today.


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