Enduring pitfalls are visible during this so called economic recovery

At first glance, the North American economy appears to be on a recovery path.

Modest gains in employment continue, retail sales are improving marginally and house prices seem to have stabilized.

Investor sentiment surveys and many economists see higher growth and rising stock markets. Hence, is the worst behind us? And can we look forward to a better economy? Nevertheless, there are all kinds of lights flashing “caution.” There are several reasons for dissent nowadays, enduring pitfalls.

Optimists point out that economic indicators hint that the self-sustaining phase of the business cycle may be close at hand, with the watched leading indicators published by the Economic Cycle Research Institute on an upward trend. Money supply, the fuel for equity prices, and credit totals reflect optimism.

It is appropriate, however, to examine the current situation more closely.

One should dismiss leading indicators as a worthwhile signal as too often they have proved to be of little significance. It should be noted that bullish sentiment about the stock market has returned with a vengeance. Just over 65 per cent of those questioned about the stock market are optimistic.

A contrarian point of view, usually one that works more often than not, would have to infer that most of the good news, already has been discounted by the stock market at these levels. Also, speculators have returned to the market in a mood reminiscent of the previous decade. Lower quality issues are in the forefront of market activity, not a good sign.

Given the foregoing, what would justify a sceptical attitude, aside from the enthusiasm shown by the market?

Historically, the housing sector leads economic recoveries. However, so far, home construction and house sales show no strength.

The Shiller Home Price Index has resumed its slide after a pause earlier in the year; there are huge inventories of unsold houses – and that casts a shadow on future prospects in this industry.

Usually, low interest rates trigger an upswing in home sales, but this time that has not occurred.

The gargantuan deficits by the U.S. federal government, and, to a lesser extent by its Canadian counterpart, certainly remain a cause for concern. At some point investors will realize that those levels simply cannot continue, and they will demand higher interest rates. Then, too, the shock from inevitable and widespread cutbacks in government spending will put funding pressure on outlays.

While the economic recovery has been better than anticipated, the major hurdles for a real revival remain. It is not yet time for sober forecasters to capitulate and eat humble pie.

Bruce Whitestone