Despite tremendous gains in stock prices since March 2009, concern remains among many investors that the U.S. economy will fall back into a recession later this year, or next. Obstacles cited often include:

• Unemployment remains high
• Higher taxes dampen consumer spending
• The still-struggling housing sector
• Barriers to obtaining credit, felt by consumers and small businesses alike
• Whopping state and local government deficits, forcing layoffs and cutbacks
• Another credit shock (will Greece and Portu­gal default?)
• Federal deficits projected well into the future

Despite these concerns, there is mounting evi­dence that the economic recovery now underway will gain momentum. The challenges listed above may well constrain whatever expansion may follow, but that is quite different from a double-dip recession.

Although the unemployment rate is high, jobs were gained in March than in any other month in the past three years. Initial jobless claims have dropped to the lowest level since September 2008. Construction and manufacturing jobs, which had pre­viously been among the worst sectors for job creation, showed substantial gains, as did temporary help—a leading indicator for future job growth. Taken to­gether, these numbers suggest that the painful unem­ployment and underemployment situation may have reached a turning point.

According to The National Association of Realtors, pending home sales rose 8.2% in February, the most recently reported month. This is the second-largest gain on record and the single largest monthly gain since October 2001. Mortgage applications are up. Buyers are taking advantage of the extended federal tax credit. And, home prices are stabilizing. The S&P/Case-Schiller home-price index climbed 0.3% in Janu­ary following a similar gain in December. This index was down 0.7% from January 2009, the smallest year-over-year decrease in two years.

Stock prices, a leading economic indicator, are forecasting recovery. The S&P 500 Index enjoyed its best first quarter in 12 years, posting a gain of 5.4%.

Although many well-documented problems in the financial system remain, the broad economy appears to be in the early stages of expansion.

The Federal Reserve has indicated it will likely retain its accommodative monetary policy for several months—until employment growth signals that the economic expansion is sustainable and can withstand gradual tightening. Neither inflation nor deflation poses a great risk now, and we trust that the Fed will use the tools at its disposal to maintain this balance.

Meanwhile, corporate earnings are up sharply and will likely continue to grow. American companies are flush with cash, and hoarding may give way to spend­ing as confidence improves.

For these reasons, we expect to see higher stock prices ahead and only slowly rising bond yields.

However, we could be wrong. The prudent inves­tor recognizes the risks and uncertainty in the market­place and maintains a well-diversified portfolio. We strongly encourage investment strategies designed to avoid big mistakes rather than take big risks. These strategies have served us and our clients well during the past decade—through two of the biggest down market cycles in the past 75 years.

R. Kevin O’Keefe, CIMA®, AIF ®
Chief Investment Officer
Kevinok@firstaffirmative.com

This entry was posted on Monday, May 3rd, 2010.