On Apr 10, 2013, the S&P 500 index reached its all-time high of 1589.07 breaking its previous record intra-day high of 1576.09 on Oct 11, 2007. Its market capitalization has also swelled from just $5.9 trillion in 2009 to nearly $14.0 trillion. Close on the heels of the S&P 500 ascendancy, almost all the major indices except the Nasdaq Composite have hit record highs.
Although the S&P 500 index is regarded as the more accurate measure of the U.S. stock market and the economy as a whole, the spurt in indices across the board apparently signifies that the recovery from recession is complete and the economy is on its way up. Is that so? Before going further with the argument of whether the economic recovery is a mirage, let us look into the possible factors that have propelled the indices.
Favorable Stress Test Results
The stress test results, as revealed by the Federal Reserve in early March, showed that 17 of the top 18 banks in the country had the requisite wherewithal to withstand a crisis, simulated by severe conditions such as an unemployment rate of 12.1%, housing price decline of 20%, share price fall of 50%, and an aggregate loss of $462 billion in the banking system. The results signified a marked improvement in the liquidity of banks and denoted that the economy was relatively stronger than it was four years back when it was plagued by recession.
As part of the study, the Fed analyzed loan- and account-level data of over two-thirds of the $4.2 trillion held in accrual loans and leases by these banks. These included data from 350 million domestic retail loans, including credit cards and mortgages, and more than 200,000 commercial loans.
Furthermore, the stress tests evaluated the banking system horizontally, rather than taking each bank in isolation. Consequently, it provided reliable information on the resilience of the banks, thereby signifying a relatively steady economy.
Rise in Home Prices
Another outwardly positive signal in the economy has been the continuous rise in home prices, as per the data from S&P/Case-Shiller index. Tracking changes in the residential real estate values across the country, the S&P/Case-Shiller Home Price Indices are arguably one of the best measures for the U.S. residential housing market and are calculated on a monthly basis using a three-month moving average.
The latest data from the January report divulged that although home prices are yet to reach the pre-recession peaks, they have risen the fastest since 2006. The 10-city composite climbed 7.3% in the trailing 12-month period, while the 20-city index escalated 8.1% as all cities posted gains on a yearly basis.
The U.S. job market was also supposedly improving as according to the latest U.S. job report, unemployment rate decreased to 7.6% in March from 7.7% in February with about 88,000 jobs added in the market. Although the job additions were significantly lesser than expected, the more talked-about point in the report was the drop in the unemployment rate, which apparently appears positive and augurs well for the economy that is limping back to normalcy from the wounds of a deep recession.
The Critical Analysis
However, a critical analysis would reveal that the dip in the unemployment was primarily attributable to 500,000 Americans dropping out of the labor force, which dragged the labor participation rate (the percentage of the population within the demographic age of 16 and over in the labor force) to a 34-year low of 63.3%.
Since reaching its zenith at 67.3% in 2000, the labor participation rate has declined over the years as discouraged and frustrated Americans left the job market only to return when conditions briefly improved. However, the gradual retirement of an aging Baby Boomer population and a recession in late 2007 has continuously pegged back the labor participation rate.
Although a smaller pool of workers looking for jobs are likely to get them easily, it restricts potential economic growth of a country and consequently is not a healthy sign for the U.S. economy.
A housing recovery would also do wonders for the U.S. economy that was plunged into one of the worst recessions ever witnessed by the country by a subprime crisis primarily led by a housing bubble. However, a deeper analysis would suggest that the surge in housing prices was the fallout of bulk buying by institutional buyers.
With a substantial amount of dry powder in their kitty, institutional buyers are making a beeline to mop-up assets in distressed sales. Listed investment and capital management firm such as The Blackstone Group LP (BX - Free Report) as well as hedge funds and private real estate investment firms like Colony Capital and GI Partners are amassing a huge portfolio of single-family homes. Blackstone has already spent over $3.5 billion for more than 16,000 single-family homes and is reportedly spending about $100 million a week to further increase the tally.
These institutional buyers typically have a profit-based approach and their investment model is based on piling a huge pool of real estate assets, which are then rented out to generate a fixed monthly income with the homes serving as collaterals.
The biggest question left to ask therefore is – Would this benefit the common man and the economy as a whole? Or is this just a ploy of the rich to be super-rich? What also remains to be seen are whether other asset management firms such as Kohlberg Kravis Roberts & Co. (KKR - Free Report) , Affiliated Managers Group Inc. (AMG - Free Report) , and AllianceBernstein Holding L.P. (AB - Free Report) , each carrying a Zacks Rank #2 (Buy), jump on the bandwagon.
Furthermore, although stress test results were apparently positive, it had inherent drawbacks and was not entirely trustworthy. The full specification of the model used for evaluation of the stress tests is not disclosed to the banks, making industry experts skeptical of the authenticity of the tests.
Critics have alleged that fudged data were used to project a shadow economic recovery and the true picture was not revealed to continue receiving government bail-outs to avert a rerun of an asset bubble.
To add to the woes, the U.S. runs the risk of a debt default and a possible reduction in credit rating when it reaches its debt ceiling on May 19. The U.S. government voted on legislation in January this year to raise the debt ceiling for three months as a short-term fix to delay a debt default. Sovereign rating of the U.S. was earlier downgraded in Aug 2011 from AAA to AA+ due to a burgeoning debt burden and lack of concrete fiscal consolidation plan.
Ever since then, the government has periodically increased the debt ceiling to avert further downgrade. The government also avoided a fiscal cliff by staving off widespread tax increases and deep spending cuts by accepting a brokered Senate compromise, which otherwise would have plunged the economy into a double-dip recession with unemployment back in the 9% range.
The obvious question then that comes to the fore now is whether the current stock market boom then truly represents a spurt in the economy or is this just a mirage? Are all these positive signals worth believing or are we in for another surprise around the corner?