Spring Has Sprung

As Spring begins to come to the Northern hemisphere, green shoots are appearing not just in the shrubbery but in sickly economies. I'm not saying that there won't be some cold and rainy days in the months to come, but for the moment, it seems, winter is over. Obviously this is a big deal for real people and for beleaguered stock markets. The prospect of an economic ice age was what terrified investors, and the feeling now, that the world has averted depression, is a big reason equities in many parts of the world are in a sustained rally.

As of the end of last week, there had been 40 upticks in key indicators of economic activity around the world. The United States, China and the developing economies are leading the renaissance, which is consistent with past recoveries. Europe and Japan are lagging, although they too are showing a few (albeit still feeble) signs of life. Of course, just as one robin doesn't make a spring, there are a number of key indicators, particularly those related to employment and housing, that are still weakening.

I believe the single most important number to watch is the manufacturing purchasing managers' index (the PMI), which has seven components, ranging from factory output and new orders to delivery times and inventories. The PMI has always been the most prescient indicator of both the health of the economy and stock prices. A PMI above 50 means that an economy is growing, while one below 50 indicates an economy in decline. China just reported a PMI of 52.1, meaning that the world's third-largest economy is growing again. However, the real key for forecasting is the so-called second derivative, or the rate of change of this metric. JPMorgan compiles a global manufacturing PMI that I pay close attention to, and it has just gone up for the third straight month, to 37.2, after 12 consecutive losses. In other words, the global economy is still in recession, but the rate of change for the past three months shows that we're coming out of the nose dive.

Another important point: this leveling-out occurred before stock markets began to rally. That climb has been violent and dramatic enough to capture everyone's attention, and is sure to further reinvigorate the confidence of both businesspeople and consumers. My experience has been that the stock market is a very perceptive forecaster of the direction of the economy.

Even as March's PMI was rising, the new-orders component went up, as did factory output. Consumer demand has strengthened. At the same time, inventories have fallen to new lows. The classic economic recovery begins with new orders and output rising, spending stabilizing and inventories falling. JPMorgan says that the key now is for consumer spending to remain stable, so that inventories stay at such low levels that the liquidation cycle ends quickly. In the fourth and first quarters, global industrial production declined at a staggering 25 percent pace. The bank estimates that in the second quarter, a lower fall in the 5 to 10 percent range would add about 4 percentage points to global GDP.

Could this revival be just random noise, or a flash in the pan that will be followed by more deterioration and another sickening drop in the global economy—and in the stock market as well? Of course—and there are a number of very serious problems still to be solved, especially the banking crisis. I suspect the recovery will be sluggish. But I think that a 1930s-style depression scenario is now very unlikely. Refinancing of mortgages has surged, and money growth (the M2 indicator) is strong. The lagged effect of interest-rate cuts is finally starting to kick in, and lower gasoline prices and tax refunds are buoying spending. Mortgage rates in countries with housing busts are falling, and spending for consumer durables like automobiles and flat-screen TVs is at rock-bottom levels.

Meanwhile, the colossal global stimulus package keeps expanding. President Obama's U.S. program only began to take effect on April 1. The Congressional Budget Office has estimated it will add 4 percentage points to U.S. real GDP in both the second and third quarters. Stimulus programs are also beginning to bolster economies from Asia to Eastern Europe. This is what stock markets long to see. My guess is that we are about halfway through a monster stock-market rally (although there will be periodic sharp corrections) comparable to the one that occurred in similar circumstances in 1938. What happens after that depends on the data, luck and the fortunes of war, but I doubt we will see new lows.

I should point out that many learned observers are still pessimistic about both the global economy and the stock market. Last week at a dinner in New York for hedge-fund managers, the crowd was virtually unanimous that we were having a bear-market rally that would be short-lived. A survey by the host revealed that the vast majority expected a painful retest of recent lows, and over half believed the S&P 500 would fall from its current level of 820 to 600 by year's end (the low in March was 676). Only 20 percent expected the recession to end this year. At least a few people still expect April to be cruel.