It’s No Time to Get Complacent

01/11/2012 10:29 am EST

Focus: STOCKS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The improving US economy is far from healthy, and poses risks that may no longer be fully priced in, writes MoneyShow.com senior editor Igor Greenwald.

We’ve had a very nice three-week stealth rally, starting the week before Christmas just after everyone had concluded that God and Santa Claus were dead, and running right through the start of a new year that’s suddenly looking considerably less terrible than seemed likely just a few weeks earlier.

In those three weeks, the S&P 500 has recouped 7%, first when no one was looking, and eventually to the delight of multitudes hankering for a good new year’s omen.

Better still, there is a compelling story underpinning the action, which is that the US economy seems to be on the mend, with auto and furniture sales strong, decent hiring driving unemployment to as low as it’s been in nearly three years, and even real estate and construction showing signs of stirring.

The S&P is now back exactly where it was just before Congress torpedoed economic confidence with an inconclusive placeholder for a debt deal.

Pain postponed is not the same thing as a cure, and austerity dictated by political gridlock could yet grind this economy and market into dust. But for the moment stocks are not merely back to where they were before August, they’re there with much better momentum after an ordeal that’s washed out lots of longtime investors, to say nothing of fair-weather fans.

I’ve been writing about surging housing plays and some of the sprightlier banks, and it’s been hard not to get infected by the evident optimism about such stocks and their potential to run much further.

So this is as good a time as any for a reality check. We face serious long-term problems and grave near-term risks, with no consensus about the solutions. The US economy is swimming against the tide of the slowdown in Europe and China.

And the injuries it has accumulated since 2007 have only just begun to heal, so its resilience to external shocks remains in doubt. Corporate profits have soared at the expense of stagnant pay, leaving the recent consumer spending splurge to be financed the old-fashioned way—via credit cards.

The millions of construction and middle-management jobs lost to the Great Recession, to the extent that they’ve been replaced at all, have mostly been replaced by low-end service ones.

A persistent credit crunch in the mortgage market is keeping millions of foreclosed properties vacant, while former homeowners drive up rents.

No wonder heavyweights from Bill Gross to Bridgewater Associates fear a trap door could open under stocks at any time. They likely agree with Warren Mosler that “potential volatility is as high as it’s ever been.”

Meanwhile, expected volatility is all the way back to normal from last fall’s panicky peaks. The market seems to be expecting nothing more challenging than a slow grind toward last year’s highs.

Sentiment among the owners of small businesses has perked up nicely from September’s lows. But the real telltale is the percentage of those polled complaining about “poor sales” as their biggest problem.

And that number remains above the highs seen in previous business cycles, suggesting we’re still not back to business as usual. And won’t be for a long time to come.

This is no time to drop the guard.

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