MSN Money Video

Video on MSN Money
This video requires an updated version of the free Adobe Flash Player
More video on MSN Money
Arrow © Photodisc/ Superstock

Extra5/11/2009 2:57 PM ET

Stocks rallying, but is economy?

The Dow's recent march upward has many investors beginning to think the bull market is back. Yet for average Americans, there's likely more pain ahead.

By Catherine Holahan
MSN Money

Is this two-month market upswing a recovery or a false rebound?

The long rally has spurred many investors to call a bottom and return to stocks. The optimism is understandable. The Dow Jones Industrial Average ($INDU) is up more than 30% since its March 9 low, and even billionaire investor Rupert Murdoch is saying things are turning around.

"It is increasingly clear that the worst is over," Murdoch said last week. "There are emerging signs in some of our businesses that the days of precipitous declines are done."

Many have called a market bottom in this recession before, only to be proved wrong by the next ferocious sell-off.

This time, however, the optimism is grounded in some good data, according to many leading economists and analysts. The Labor Department has announced that the rate of job losses slowed in April. Consumer spending improved for the month. Battered retailers such as Macy's (M, news, msgs) have boosted their outlooks. All are indications of better days ahead for investors.

But just because the stock market is ready to start heading up doesn't mean the economy has hit bottom. In fact, a real recovery could still be far off.

The truth is that all the recent good news isn't really that great -- it's just less horrible than the scenarios many investors and business leaders had priced into the market and company forecasts. The unemployment rate of 8.9% is still the highest in 26 years, and it's likely to continue climbing, just not at the furious pace seen earlier this year. Many economists predict unemployment will exceed 10%, likely in the second half of 2010, before the trend begins to reverse.

Video on MSN Money

Catherine Holahan
Is the recession ending?
Earnings reports from retail giants Macy's, Wal-Mart Stores and Nordstrom will help investors decide whether an economic recovery is under way.

Similarly, the improvement in consumer spending last month is still not significant enough to help many retailers avoid losses. Spending increased 0.7% in April, according to a report by Goldman Sachs Group and the International Council of Shopping Centers. That increased activity helped lower-priced retailers such as Wal-Mart Stores (WMT, news, msgs) post better-than-expected sales. But it didn't do much for pricier department stores such as Macy's, which saw greater-than-anticipated losses for the month. That's one reason retailers shed 46,700 jobs in April and many malls could still go out of business.

"In terms of the free fall that I think we experienced in the fourth quarter and the first quarter -- that's over," says Nigel Gault, the chief U.S. economist for research company IHS Global Insight. "Has GDP (gross domestic product) hit bottom yet? Probably not. Another decline is likely in the current quarter."

The government's bank stress test results were also not entirely good news, though they were better than many investors had feared. Bank of America (BAC, news, msgs), Wells Fargo (WFC, news, msgs) and others need an estimated collective $75 billion in new capital to guard against losses from a continued recession, and they could need much more if the economy gets substantially worse. However, there are signs that private investors are willing to buy more bank debt, and $75 billion is still better than the hundreds of billions some analysts had anticipated the banks would need.

That said, better-than-expected news is what fuels market upswings, and it does seem now that the direst economic predictions likely will not come to pass.

"The stress test of the banks could have been a disaster," says Eric Ross, the director of U.S. research at Canaccord Adams. "Instead . . . everything is just a little bit better than people expected."

More than any individual positive sign, the reduced volatility will help fuel the recovery. Before, business leaders couldn't make predictions about what their sales would be like in the next month, let alone in the next year. That kind of environment freezes investment just as much as the inability to get loans, Ross says.

"The thing that made last year scary was the free fall. It made it impossible for anybody to make any sort of rational business decision except duck and cover," Ross says. "Now we are able to make more rational investments."

Rate this Article

Click on one of the stars below to rate this article from 1 (lowest) to 5 (highest). LowHigh