Rebound or Head Fake? Economy Affords Little Visibility

Lots of people are betting on a sharp recovery, but the evidence is far from overwhelming.
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Figuring out what the economy will do next is like coasting downhill on a bicycle -- blindfolded.

Suddenly the slope steepens -- a sharp jog down -- and then just as suddenly it flattens out. In that instant, the rider can only guess whether he has come to the bottom or if he's merely passed over a dip, with the valley floor still a ways off. The market, in the recent rally, is betting on the former scenario. Most economists figure it's the latter.

Recent reports on economic activity have been surprisingly strong. This week it was the October numbers on construction spending and personal consumption and the November purchasing managers' indexes. Last week it was the October durable goods and home sales reports. The week before that, October housing starts. The week before that, October retail sales.

Meanwhile, some companies (

Cisco

and

Oracle

, notably) have been offering up anecdotal evidence that business is on the verge of picking up. All this has been fodder for the market as it has surged from its September lows. The recovery in the economy and earnings will come sooner, and be stronger, than most people are forecasting, according to this view. The time to be in stocks is now.

But economists generally don't see it that way. The step-up in recent economic reports is merely a snapback from the severely depressed activity that followed Sept. 11. Extrapolating a trend from it, as the stock and bond markets have done, is foolhardy.

Square One

"We're just rebounding from a sharp drop," says Raymond James chief economist Scott Brown. You start looking through the details, there's no real evidence of strength here. A lot of the data are just telling us we're back where we were before the attacks."

The November Purchasing Managers' Index, for instance, came in at 44.5, a big jump up from October's 39.8 and much better than economists' consensus forecast of 41.7. But it was still below September's 47. Durable goods orders jumped 12.8% in October, but on an absolute basis they were only slightly higher than in August. And if you take out transportation orders (which are extremely volatile), the total level of orders is still below August. You can go through the same exercise with a lot of other reports.

The economy experienced, according to Salomon Smith Barney's Chris Wiegand, "an extremely localized V." But that recovery from the severe downdraft that followed Sept. 11 doesn't portend a larger, V-shaped recovery in the economy.

Jobs will continue to get hit hard (as evidenced in today's employment report), and the hugely important Christmas season is going to stink. Recovery's on its way, but it ain't here yet. In the meantime, the next round of reports, in their weakness, will reveal the recent signs of strength were merely a bounce. Many investors will find themselves caught offsides.

Time Will Tell

For now those investors aren't listening to the Cassandras in the economics profession, and one can see why. Don't these guys have a habit of getting it wrong? Weren't most of them blindsided by the slip in the economy? (Counterpoint: Look how many recovery rallies investors have falsely put their hopes in so far this year.)

The truth is, says Lehman Brothers senior economist Ethan Harris, "There's no way to distinguish between the first step in recovery from a simple payback. It's more of a gut call."

For investors trying to weigh committing more money to stocks vs. taking profits, it makes for a hard decision that has as much to do with one's predilection for risk as anything else. If the market is right, and the recovery is at hand, not getting in now could mean losing an opportunity. But if the economists are right, getting in now could mean losing your shirt.