IS A DOUBLE-DIP RECESSION POSSIBLE? October 2, 2009

The economic slowdown and severity of the stock market decline last year, and in January and February of this year, had the financial media and investors convinced the recession was headed down into the next Great Depression, and the Dow was therefore headed down to 1,000.

I didn’t believe it. After being bearish and in downside positioning last year enough to be up 9.2% for a year when the S&P 500 was down 36%, I turned bullish in early March. In this column I predicted a substantial rally would take place.

My reasons were that in the severe doom and gloom the market had been beaten down to an extreme oversold condition beneath key long-term moving averages, investor sentiment had reached an extreme level of bearishness and fear usually seen at important market lows, and I expected the massive government intervention was going to create a temporary improvement in the economy.

I received a lot of flak. Couldn’t I see how fast the economy was deteriorating, and that government bailout efforts were only going to result in the economy melting down further from the weight of the overwhelming Federal debt being created?  

At the time I also said I expected any improvement in the economy would be temporary, that the rally would end, and the downside would resume to another low and the next buying opportunity “in the October/November time-frame”.

The rally has lasted longer than I expected, the market having become very overbought above its long-term moving averages, and investor sentiment having reversed to the high levels of bullishness and confidence usually seen at market tops, a couple of months ago. Yet the rally continued.

However, the deterioration in economic reports over the last two weeks adds another worrisome condition, raising questions about the possibility of a double-dip recession, anticipation of which would not be a positive for the stock market.

Those reports include that in the important housing sector, existing home sales unexpectedly fell 2.7% in August after rising for four straight months, and new home sales rose only 0.7% after being up 6.5% in July. Both disappointments came even though the soon to expire $8,000 bonus to 1st time home-buyers (which has been responsible for 30% of home sales in recent months) was still in effect.

Other recent reports were that Durable Goods Orders declined 2.4% in August after rising 4.8% in July; that Consumer Confidence fell back again in August while the consensus forecast was that it would improve.  

The market was spooked on Wednesday when it was reported that the Chicago Purchasing Managers Index fell to 46.1 in September (after improving to 50 in August). A number below 50 means business is slowing, while above 50 would indicate business expansion. The consensus forecast was that the index would rise to 52 in September.

On Thursday, the ISM Mfg Index for September disappointed with a decline. On Friday the Labor Department reported that 263,000 more jobs were lost in September, much worse than the consensus estimate that only 175,000 would be lost. Also on Friday it was reported that Factory Orders declined 0.8% in September, the largest monthly decline since January.

Auto sales have apparently also fallen back into a dark hole after the government’s ‘cash for clunkers’ bonus program ended. The program did not jumpstart ongoing car sales as had been hoped. While some foreign makes saw sales increases, General Motors is reporting a huge 45% plunge in September sales, and Chrysler a 42% decline. Ford reported only a 5.1% decline, but factoring out a big jump in fleet sales, Ford’s sales to consumers fell 14%.

Meanwhile, the American Bankers Association reported on Thursday that increasing job losses continue to weigh on consumers, with home-equity and bank credit-card delinquencies rising to new record highs in September.

With investor sentiment now so bullish, it will no doubt be as unpopular as it was in March to predict a temporary economic improvement and substantial stock market rally, to now say that it looks like the green shoots of summer were temporary, as expected, fueled not by consumer spending, but by government spending disguised as consumer spending.

Those cash bonuses to home and auto-buyers amounted to more than the down-payments they needed to make the purchases, so why wouldn’t consumers take advantage of them. And the purchases did give a temporary boost to the economy, but it could not be described as consumer-driven spending by any stretch of the imagination.

Meanwhile, the stock market rally has reached the opposite extreme of its condition in March, with the major indexes very overbought above their key moving averages. Investor sentiment is at the opposite extreme of last March, now convinced the economic problems are over after all, and only good times lie ahead.

While those conditions have been in place for a couple of months now with the market paying no attention, can the market also ignore the addition of a potential double-dip recession beginning to show up in the economic reports?

Sy Harding is president of Asset Management Research Corp, publishers of the financial website http://www.streetsmartreport.com/, and the free daily market blog, www.syhardingblog.com.