Investors must roll with the punches until recovery begins

SERIOUS MONEY:  JAKE LA Motta, the Bronx or Raging Bull, was born on this day in 1921 and during the summer of 1949, he beat Frenchman Michael Cerdan to become the boxing world middleweight champion, writes CHARLIE FELL

A raging bull has also been apparent in downtown Manhattan for some time now and, by early June, investors emulating LaMotta’s explosive fighting style have pushed stock prices almost 40 per cent higher from their March low, the largest 13-week advance in more than 75 years.

The strength of the “green shoots” rally has caught many investors by surprise, but there is no need to commit surplus cash just yet as lacklustre upside volume suggests it is doubtful whether the advance possesses anything like the notorious chin of the Bronx Bull who once boasted that “no son of a bitch ever knocked me off my feet”.

Indeed, severe bodyblows over the past fortnight in the form of disappointing economic data have stopped the market in its tracks and resulted in a standing count that confirms “less bad” numbers or the second derivative is not sufficient to keep this unconvincing bounce on its feet.

The economy must deliver as the stock market is priced for recovery. Anything less than positive growth during the year’s second half would leave the “green shoots” thesis on the ropes, just like its predecessors that include the “goldilocks” economy, “house prices never go down” and “global decoupling”.

Furthermore, investors also appear to be adopting the mindset that a garden-variety economic recovery is in the offing through 2010, in spite of a persistent flurry of punches that has left US households reeling. The overstretched consumer has been counted out and investors need to accept that households are unlikely to recover any time soon.

The stock market dropped below its 50-day moving average and held only marginally above its 200-day moving average following the disappointing employment report for June, which revealed a 467,000 drop in payrolls and the 14th consecutive monthly decline year-on-year.

It is clear that the ongoing economic malaise has taken a heavy toll on the labour market and the cumulative job losses since the recession began, at some 6.5 million, exceeds the total losses of the previous seven recessions combined.

Additionally, the near 5 per cent drop in non-farm payroll employment from the business cycle peak to roughly the same level as nine years ago is unprecedented in the modern era. The unemployment rate edged up 0.1 per cent last month to 9.5 per cent, a 26-year high and, though this was less than feared, it would have been higher but for the 155,000 decline in the labour force.

The five percentage point increase in the jobless rate from its cycle low is also unprecedented in the modern era and the picture is even more disturbing if a broader measure of unemployment is used.

The jobless rate including those who are working part-time for economic reasons and those marginally attached to the labour force has more than doubled from a cycle low of below 8 per cent to a current reading of 16.5 per cent. The Centre for Labour Market Studies believes the employment situation to be even worse and, counting the number of jobless according to previously used methodology, it puts the unemployment rate at more than 18 per cent.

The economic downturn has not only resulted in massive job losses but has also reduced hours worked for those who are fortunate enough to remain in employment.

The average working week dropped to 33 hours in June, the lowest level since the series began in 1964. This has negative implications not only for consumer spending with average weekly earnings dropping by almost 2 per cent in June, but also suggests that a turnaround in employment is some way off.

After all, businesses typically work their existing employees longer before they increase their headcount and, even then, they will usually turn to temporary workers before they employ permanent staff.

Falling real incomes due to rising unemployment combined with massive wealth losses and overstretched balance sheets mean that US households face a protracted period of rehabilitation, meaning that hopes for a consumer-led recovery are wishful thinking.

Household net worth has dropped by more than $12 trillion or almost 20 per cent since the end of 2007, owners’ equity as a percentage of household real estate declined by seven percentage points to just 41 per cent over the same period, while outstanding household debt to GDP remains 30 percentage points above the level that prevailed just seven years ago.

US households’ firepower is clearly strained and the inevitable period of frugality should see consumer spending to GDP fall from its current 71 per cent to a new normal of around 65 per cent. Subpar economic growth is virtually assured for several years as too is disappointing profit increases and equity valuations below their historical mean.

An era has ended and investors need to adapt if they wish to avoid a beating of the sort that Jake LaMotta suffered during his final bout with Sugar Ray Robinson.