Optimism about a recovery starting to fizzle

John W. Schoen Senior producer • Profile • E-mail

What happened to all the optimism?

Less than a week ago, many people were celebrating the beginning of the recovery. The Federal Reserve itself claimed the economy is “leveling out.”

Now some investors and market watchers say the stock market may have overestimated the prospects for an economic rebound — and share prices could be due for a bigger pullback after a 50 percent surge since March.

"The market has gotten way ahead of the reality on the ground,” Pimco's Mohamed El-Erian, co-chief executive officer of the largest bond fund manager in the world, told CNBC Friday. "We are yet to see a durable and sustainable recovery, but the market has gotten ahead of the process by pricing that in."

On Monday, some investors echoed those second thoughts, sending stocks 2 percent lower and stalling a rally that had pushed the market up 15 percent since mid-July.

The initial exuberance followed economic data over the past few weeks showing that one of the worst recessions since World War II many be ending. Job losses slowed in July. Many forecasters believe the U.S. Gross Domestic Product will likely turn positive again in the third quarter after steep declines since the recession began in Dec. 2007.

The relentless retreat of housing prices seems to be slowing. And massive infusions of government cash — the $787 billion economic stimulus package, the $700 billion bank bailout and the Federal Reserve's $1 trillion intervention in the financial markets — seem to be having the desired effect.

The government-led effort may have stopped the bleeding. There is less evidence that the second phase of recovery is taking hold, however, said Barbara Marcin, who manages the Gabelli Blue Chip Value fund.

"That (government intervention) is supposed to jump start the real economy and start consumer spending,” she said. “In previous recessions with stimulus programs, autos and housing get under way, they start to create a little confidence, banks start to lend more, consumers start to borrow more and the second part takes off. I don't think there are any signs of that. I think we're six or nine months ahead of ourselves.”

Stock investors also have been encouraged by the latest round of quarterly corporate earnings reports, which came in stronger than expected. But a closer examination shows much of that profit came from cost cutting — laying off workers — and then selling off inventories to meet limited demand.

That’s not a formula for long-term growth. For that, consumers need to get back to levels of spending not seen since the economy began contracting 18 months ago. But consumer confidence readings fell sharply in July, indicating a pick-up in demand isn’t imminent.

For now, consumers face a number of burdens that may crimp their spending for some time.

The biggest drag on spending is the high level of unemployment. Almost 7 million workers have lost their paychecks since the recession began. Unemployment benefits and stimulus tax cuts have helped, but confidence in the job market remains weak. That’s one reason the savings rate has jumped. Households are saving for a rainy day and trying to restore wealth lost to the housing market collapsed.

Housing wealth still is evaporating as the pace of foreclosures rises and those homes are sold into a distressed market. Once the housing market stabilizes, those unsold homes will likely continue to weigh on house prices.

"You’ll be left with probably six million excess homes, the way we calculate it," said Jason Trennert, chief investment strategist of Strategas Research Partners. "And with 1 percent household growth a year, it takes a while to get through that."

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