Beware of the Lurking Bear

Today, the stock market, as measured by the S&P 500, made a new high for the year. The S&P closed at 951.13, its highest close since November 5, 2008. Stocks were buoyed by news that commercial lender CIT Group, a critical source of funding for many small-to-mid size businesses, had arranged for $3 billion in additional financing from its bondholders, averting what only last week had seemed like certain bankruptcy. In addition, with the earnings reporting season for the second quarter having recently begun, there is a growing sense of optimism that corporate earnings might come in better than originally expected. (Of course, no one really knows for certain why the stock market went up or down, even after the fact, but we'll save that topic for another time).

The S&P 500 is now up 40.6% from its closing low of March 9th. After stagnating a bit from mid-June through mid-July, the market has resumed its recent upward trend, sporting a gain of 8.2% in the past six trading days alone.

Despite the rally, which is most welcome, I'm beginning to feel quite uneasy. For one thing, volume has been unconvincing. I learned a long time ago that relative volume is one of the most significant indicators in any major move, whether up or down. A big move, on strong volume, can indicate a longer-term shift in the market trend. On the other hand, a big move, on light volume, indicates that the market lacks conviction. When the move in question is upward, the light volume becomes a bearish indicator.

As to the recession itself, history implies that stocks are a "leading indicator," meaning that the stock market moves before the economy does. Therefore, for stocks to move upward as they have, while the economy is in difficult shape, is not a strange thing. If anything, it portends that positive economic news might be just over the horizon.

I remain unconvinced. I think that the risk to the economy now is not necessarily one of never-ending recession. Eventually, we will experience a couple of consecutive quarters of GDP growth, however faint, and the recession will officially be over. My primary concern is with the outlook for the recovery, which is unlikely to be robust, restrained by the employment picture. It's not just that unemployment is poised to shoot past 10% within the next month or two. There are two other employment-related statistics, which I find to be much more troubling than the "headline" unemployment number.

(1) The duration of unemployment: The average length of unemployment is now at 24.5 weeks. This is the longest since the government started tracking this data in 1948.

(2) The under-employment rate: In addition to those who are out of work, there are millions of people who are working part-time because they cannot find full-time work. When adding all of these people to the "core" unemployment number, the national "underemployment rate" is above 16%. That is a frighteningly large number.

It's going to take an awfully long time to put that many people back to work. Add to that the anticipated job-killing effects of all of the tax increases that the President and Congress seem intent upon delivering, and it begins to look like we might be facing something of a lost decade.

In the face of this, can the stock market rise further? Technically, yes. However, I'd bet on a pretty big pullback between now and Labor Day, as market participants begin to focus on the still-deteriorating economic fundamentals.