Cautious optimism

Three months into a near 40% rally in equities it is time to take stock and assess the economic outlook. Talk of a new bull market is still premature and further upside will depend on a sustained improvement in economic fundamentals and company earnings, or at least their ability to surprise on the upside.

The improvement in economic fundamentals suggests Q1 2009 marked the point of greatest weakness. Indeed, had activity continued to fall off a cliff before long we'd be back in the Stone Age!

However, despite talk of green shoots, most economic data is still negative:

Moreover, after such a sharp and synchronised cut in output, to what extent is the improvement down to restocking as opposed to a sustained demand growth? Whilst forward looking indicators such as OECD leading indicators have ticked up, measures of actual demand such as consumer spending are still in decline. Indeed, consumer demand is unlikely to improve until unemployment and the savings rate stop rising and the supply of credit increases.

Indeed, in an interview with CNN this week, US Treasury Secretary Timothy Geithner suggested consumer demand and credit supply will remain weak for some time.

"You're going to see less credit flowing, as people go back to the point when they're living within their means. That's a healthy process for the economy... But it means that you're going to see a slower recovery than what you normally see."

So, as the G8 finance ministers noted in their communiqué this week:

"There are signs of stabilization, including a recovery of stock markets, a decline in interest rate spreads, improved business and consumer confidence, but the situation remains uncertain and significant risks remain to economic and financial stability."