All Clear Signal?

Stock markets worldwide extended the monster bear market rally last week amid a favorable response to the bank stress tests and better than expected employment numbers.  After a 40% rise in equities since March 9th, many believe the bear market is over.  So has the market issued the all clear signal? While huge government stimulus, coordinated across the globe, has cutoff the Armageddon scenario, we believe it is too early to expect a healthy recovery any time soon.

Let's start with the much-cheered April employment report released on Friday.  The economy lost only 539,000 jobs compared to the expectation of over 600,000 job losses.  Of course, 539,000 job losses in one month is a big number, and the number of job losses in this recession has reached 5.7 million.  But digging a little deeper, the April report was not nearly as rosy as the market took it on Friday.  First, the losses for February and March were revised lower by 66,000 jobs from the original reports, and the April numbers may be revised lower as well.  Government added the most jobs, including over 60,000 hired for the 2010 census. Temporary jobs declined by over 60,000, typically not a good sign for a budding recovery.  A government statistical adjustment that projects jobs added through imaginary new business creation, added 266,000 jobs. Finally, remember that a healthy, growing economy typically adds 250,000 jobs per month, yet this economy continues to lose jobs at a stunning pace.  So while we may have seen the peak in terms of monthly job losses, the economy has a long way to go before we give it an all clear.

The bottom line in our view is that stocks have run too far, too fast.  The credit markets, while showing some improvement, have not confirmed the equity market strength.  Looking at valuations, stocks are no longer cheap, considering that a price-to-earnings multiple of 15 times 2010 expected earnings of roughly $60 for the S&P 500 results in an index level of 900, a little below Friday's close (later this week, we'll discuss why a P/E multiple of 15 is likely too high).  As a result, we think the market is at risk for a correction in the weeks ahead, although the substantial cash on the sidelines in many portfolios is likely to prevent a retest of the March lows.  For investors who are overweight equities, we would view this 40% rally as a gift that should be cashed in.