An Encouraging and Dramatic Upside Reversal for Investors

An Encouraging and Dramatic Upside Reversal for Investors

Being Street Smart

by Sy Harding

An Encouraging Week For Investors! December 3, 2010.

After a strong rally in September and October, the stock market topped out short-term four weeks ago, with the Dow then declining 4% in just seven days.

In the process it broke below key short-term support levels that market technicians watch, and entered a very narrow sideways trading range, locked between 11,000 on the downside and 11,200 on the upside that it couldn’t seem to break out of in either direction.

Then came this dizzying week.

Early in the week it looked like the market might be breaking out of the range to the downside. The Dow dropped below 11,000 by as much as 70 points in intraday trading on both Monday and Tuesday. Both days it recovered before the market closed, but to levels just fractionally above 11,000, leaving traders still worried.

A break out of the range to the downside would be seen as a negative development, and that possibility seemed justified given the dire reports from Europe indicating a domino effect is potentially underway in its debt crisis, and reports from China of more moves by the Chinese government to significantly slow its globally important economy (in an effort to prevent asset bubbles and ward off inflation).

However, on Wednesday the market instead reversed and surged to the upside, the Dow gaining 249 points, its biggest one day gain since September 1. On Thursday it surged up again, the Dow gaining another 106 points, breaking it clearly out of the previous narrow trading range to the upside, just two days after it had appeared to be breaking out to the downside.

The dramatic move to the upside also seemed justified, since the bad news from Europe and China had dropped out of the headlines, replaced by very positive U.S. economic reports, including gains in consumer confidence, manufacturing activity reports, retail sales, auto sales, pending home sales, and so on.

But the week’s drama was still not over.

The improving economic reports of the last couple of months had economists convinced that the big report of the week, the Labor Department’s employment report for November, would show that 155,000 new jobs were created in November.

When the much anticipated report was released Friday morning it was a huge disappointment, showing that only 39,000 jobs were created in November. The economy needs roughly 150,000 new jobs a month just to keep up with the growing population, as more young people join the workforce.

Perhaps a bigger surprise and disappointment was that the already high unemployment rate ticked up to 9.8% from the previous 9.6%.

The report threw a curve at economists.

The dismal employment situation, and what to do about it, has been the main focus of economic and political debates, particularly since the summer’s temporary scare that the economy might be slipping back into recession. One of the most common statements in those debates has been that the economy cannot recover until more jobs are created. And on the surface that seems to make sense.

Yet history shows that employment is a lagging indicator, one of the last areas to begin improving in an economic recovery. And that makes more sense. Employers do not begin hiring additional workers until well after the economy has recovered enough that they can no longer handle improving business by simply increasing the hours of their current employees and hiring temporary workers.

So the dismal employment report should not overshadow the string of very positive economic reports of the last couple of months; gains in consumer confidence, manufacturing activity, retail sales, auto sales, pending home sales, and so on. They are the leading indicators that must improve for quite some time before employment finally begins to turn the corner.

Not that everything is wonderful in those leading areas. Investing is never worry-free.

The main leading indicators in both directions, into recessions and back out, are almost always housing and autos. That makes sense since they are the two largest purchases consumers make, usually with most of the purchase price financed, significantly multiplying the economic effect of the cash down payment, while increased home construction and auto production results in significant new business for the long stream of suppliers to those industries.

Only one of those economic engines, auto sales, seems to be functioning well so far, with the housing industry still mired in the mud. Nor have the market’s worries earlier in the week regarding Europe’s debt crisis and the intention of China to slow its economy, gone away.

So still plenty of potential bumps in the road.

But an encouraging and dramatic two-day upside reversal from the downside break that threatened the first two days of the week.

Sy Harding is editor of the Street Smart Report, and the free market blog,