Sustainable Rebound or Dead-Cat Bounce

Posted on July 7, 2009 by David Laidlaw 

All of the distressed markets which were devastated by last year’s credit crisis and global recession have rebounded from their lows. The equity markets bottomed on March 9th and have increased by about 30% since that time. The question is whether or not these improvements mark the beginning of a recovery that will persist into 2010 or whether a bear market reasserts itself as economic problems persist.

Much of the recovery has been driven by data indicating that conditions are not deteriorating as fast as they were during the latter half of 2008 or the first quarter of this year. For instance, gross domestic product “only” decreased by 5.5% during the first quarter after revisions rather than the initial reading of a 6.1% decline. Also, consumer sentiment has improved dramatically even though spending is still extremely depressed compared to last year.

The measure which best exemplifies the trend that conditions are not collapsing, but are still very weak, is the unemployment statistic. Monthly job losses are running at about 350,000 – 450,000 per month compared to over 600,000 per month earlier in the year. However, the job statistics are overwhelmingly negative since the economy needs to produce jobs each month to keep the same percentage of the population employed. There is no evidence that these numbers will turn positive any time soon.

It is always difficult to determine the effects from the market rebound on investor and consumer behavior. Many investors are still sitting on the sidelines with very defensive portfolios which include large holdings of cash and Treasury Securities. These investors may begin to buy stocks fearing that they will not participate in a continued rally. On the other hand, these investors may have been so badly scarred that they are content receiving returns of 0.5% per year or less available in money market funds. However, the longer the rally continues, the more self-sustaining since more investors will not be content holding low-yielding funds.

Stock market increases could also spur consumer spending as investors feel wealthier increasing their likelihood of spending on discretionary items. This positive wealth effect should help the economy and corporate earnings as long as another panic does not take hold.

We expect that stocks will outperform other investments over the next few years.However, global conditions are still unsettled enough that we could continue to experience high volatility and sharp losses until real economic and earnings improvements become apparent.