Can The U.S. Economic Recovery Overcome Europe’s Drag?

In an October column I wrote, “For the first time this year the trend of U.S. economic reports is potentially bottoming and turning positive. And after being bearish in the spring and summer, I like what I see in the technical charts of many markets. If only we could ignore Europe.”

That pretty much still defines the situation as we enter the new year.

Our indicators did trigger a buy signal in mid-October, and the Dow is up 16.5% from its early October low.

The U.S. economic recovery did indeed get underway, and has been gaining momentum impressively.

More importantly, the positive reports are coming from all the crucial segments of the economy; consumer confidence, home sales, new home construction, the auto industry, manufacturing, the services sector, and even more impressive, in the employment picture.

This week’s reports continued the trend. They included that construction spending was up again in November, its third monthly increase in four months, rising 1.2% versus the consensus forecast of only a 0.5% gain. Near record low mortgage rates and rising home sales are encouraging home-builders. Private construction spending is at its highest level in more than two years. Of course, that’s not saying a lot since it’s still in a deep hole. But the four-month trend reversal is encouraging.

It was also reported this week that Factory Orders rose 1.8% in November, which no doubt contributed to the report that the ISM Mfg Index rose again in December, to 53.9, its highest level in six months. Within the ISM report, new orders also rose in December, which had companies boosting production and employment.

And that no doubt contributed to both the ADP jobs report on Wednesday, and the labour Department’s employment report on Friday, which showed a big increase in the number of new jobs created in December. The labour Department report was that 200,000 new jobs were created versus the consensus forecast of 150,000. And the unemployment rate fell for the fourth straight month, to 8.5% in December from 8.7% in November, 9.0% in October, and 9.1% in September.

However, I don’t want to be misleading with my optimism since October.

It’s not a time for buy and hold investing, still a time to go after intermediate-term rallies with willingness to take profits at some point and re-position for periodic corrections. The volatility will continue.

It seems clear the U.S. economy is still on the mend since the ‘Great Recession’ ended in June, 2009, and the slowdowns in the first half of 2010 and again in the first half of last year were only temporary pauses in the recovery.

But while the recovery remains on course it is still anemic, still not producing jobs fast enough, still not cutting into the glut of unsold homes fast enough, still not strong enough to have corporations using their record hoard of cash for investment and expansion, still not on sure enough footing to assure banks they can lend in confidence of being paid back (instead of seeing the loans become more bad debts on their books down the road).

There was horrendous damage done in the Great Recession of 2007-2009, and the economy could not possibly bounce back from that much damage as fast as from previous recessions. It will take more time, and involve more hiccups along the way.

For instance, there are the record U.S. federal budget deficits and debt, which will have to be taken care of sometime down the road, perhaps painfully for the economy and therefore the stock market. A continuing economic recovery can kick those worries down the road into next year or even beyond.

But unfortunately, that’s still conditioned on ‘if only we could ignore Europe’.

It’s no longer a question of whether the U.S. economy can recover from the first half slowdown on its own without the Fed providing further economic stimulus. It’s proving that it can, and is.

Now the question is whether the momentum of the recovery can continue if the eurozone debt crisis and potential for Europe to slide into a recession remain in the headlines.

In that regard, the market’s muted response Thursday and Friday to the continuing positive economic reports was a disappointment.

For years I have referred to the monthly jobs report as ‘the big one’ because it is anticipated with such intensity, has a record for most often coming in with a surprise in one direction or the other, and for those surprises to almost always result in a big triple-digit move by the Dow in the direction of the surprise.

That the market ignored Friday’s surprisingly positive jobs report, and instead focused on the news that the yield on Italy’s 10-year bonds surged back up above the danger zone of 7%, was a reminder of the continuing influence of Europe’s problems on the U.S. market, in spite of the impressive economic recovery underway in the U.S.

For now I’m giving the benefit of the doubt to the U.S. economy, expecting it will win out as the dominant factor.