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.

The job market is sending the same kind of mixed signal. I noted here a month ago that the four-week moving average of new claims of unemployment benefits peaked in early April. Celebrated economist Robert Gordon has written that this has been an infallible indicator of the end of recession, in every case starting in 1975. That indicator has just gotten better and better, as new claims continue to gradually fall.

But other labor-market statistics make that simple story a lot more complicated. They don't necessarily throw doubt on the prospect that the recession is over, but they make you wonder seriously how robust the recovery can be.

Take a look at the chart below. It charts the probability that an employed worker will become unemployed in any given month. Right now it's about 2.75%. That means this month, you have a 97.25% chance of not getting fired. Forgive me if I don't explain the exact calculation — it's straightforward arithmetic using the statistics available from the Department of Labor.

That's good news, right? It means there's almost no chance you'll lose your job. By historical standards, this is indeed a very good number. It's not all that different that it was during most of the late 1990s, which were considered to be a boom for jobs. It was even better in 2007 before the recession hit — in fact, it was the best in history then. Never before did you have a better chance of keeping your job.

So what's not to like? For one thing, it means there's not much room for improvement. But more important, this isn't the whole story. The job market isn't just about keeping your existing job. Someone is always going to lose his job, even in the best of times — and for that person, the issue is how easy it is to get a new job. And never before in history has that situation been worse. Look at the next chart.

This is the probability that a worker who loses his job will get a new one within a month — it's less than 25%. It's at its worst level in history. It's never been harder to get a new job quickly. And you can see that even before the recession, at the peak of the last recession, new jobs were almost as hard to find as they were at the bottoms of previous recessions.

Is there room for improvement? Yes, and that's the good news. But why is it so bad in the first place? And why was it so bad even when things were good?

These are the questions that keep me up at night. I'm thrilled that we're no longer headed for a new Great Depression. But I really am not sure what we're headed for instead.

And stocks obviously aren't sure either. They feel to me like they don't want to go down. But they don't feel like they want to go up, either. If you had to say “in” or “out” on stocks now, I'd say “in.” With the worst-case scenario ruled out, at least there's more upside than downside. How much is it, though? We just don't know yet.