Where Do We Go From Here?

Green shoots continue to shoot. I'm now very confident that we've seen the worst in this recession and this bear market. For stocks, I'm confident that the March bottom will hold.

The nontrivial question is where do we go from here? It's nice to rule out zero as our destination (we couldn't have done that three months ago). But is there any upside? That's a whole other matter, and the data aren't clear about how we should feel about it.

The fact is, we're in uncharted territory. In modern times we've never had a meltdown like this one before, we have no idea what the aftermath might look like. Future generations will have this as a precedent to guide them. We today have nothing.

Take a look at the chart of the Dow Jones Industrial Average. Stocks have rallied about 40% from the March lows — by any standard that's a whole bull market unto itself, and in just three months. But they don't know what to do next. They've been stuck in a 1.5% trading range for the last nine trading sessions.

OK, even though those last nine sessions have gone nowhere, at least they represent a breakout from the steep downtrend that has defined the worst of the bear market. That's terrific — even if you don't believe in technical analysis, it signifies something good. But does it feel to you like stocks want to take the ball and run with it, now that they are out of that downtrend? It doesn't to me.

Last week I wrote about my favorite macroeconomic indicator, the growth of S&P 500 consensus forward earnings. I said that it was just about to turn positive after a year and a half of decline — and I noted that, in the past, a turn positive was always associated with the end of recession. The good news is that now it has, in fact, turned positive. I like to see a month's worth of confirming data, and now I'm happy to say that aggregate consensus forward earnings are about $27 billion, or about 4%, higher than they were a month ago.

That's great, but it's not that simple this time. There's always the risk that a seeming turnaround in earnings won't really last. There's no evidence of such a thing over the last quarter century, but as I said, we're in uncharted territory.

And you have to be at least suspicious when you look under the hood — the specific choice of metaphor here is intentional. It turns out that about half the $27 billion turnaround in forward earnings is simply because General Motors was dropped from the S&P 500 last week. Forward earnings for GM were a loss of $13 billion — and removing that loss is the equivalent of a gain. But that gain is an illusion from the macroeconomic standpoint, because those expected losses are still in the economy — they're just out of the S&P 500.

It's still a $10 billion turnaround for forward earnings, overall. But it's enough to make you at least a little cautious.