Green shoots, take 2

Markets continue to defy gravity with the MSCI ACWI index within arms length of a 40% return since mid March, prompting a growing number of investors to wonder whether the economy may be gently pulling itself out of the crisis. After all, a look at the economic releases (most recently the jobs report) continues to show signs of improvement. As mentioned in a previous post, the optimism is based on the fact that although most of the economic figures continue to worsen, they do so at a decelerating pace. Granted, that in itself is indeed good news because it signals that the economy is stabilizing and that things are more or less in control. As such, it would justify the first leg of this rally. It is its sustained pace which is most troubling as optimism is steadily replaced by euphoria brought about probably by those investors that lost big time earlier on in the crisis and are now playing catch up to at least partially cover what has become a gaping hole in their nest eggs. To that I would add another class of investors who probably think that the recession is at its last throes.

In conclusion, we should be prepared for a sharp correction, although I would add that we are unlikely to come down to the levels that existed in the middle of March since there is genuine improvement going on. The worst may indeed be behind us but that certainly does not mean that we are out of the woods. A cursory look at fundamentals suggest that a protracted recession is still the most likely scenario going forward. I would also pay attention to growing inflation risk considering all the stimulus fire power out there.