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The Panic Is Over

This article is more than 10 years old.

While some forecasters believe a rising jobless rate and more housing foreclosures could kill off a nascent recovery, we believe the panic is over and a V-shaped economic recovery is under way. It is in its earliest stages, which means plenty of economic indicators have yet to turn positive, but the signs of a strong bounce off the panic-induced lows are all around us.

Since bottoming in February, consumer confidence has had the fastest three-month increase on record. The Institute for Supply Management's manufacturing index, which fell to historic lows over the winter, has risen to signal that the overall economy is now expanding. The Richmond Federal Reserve index, a measure of manufacturing in mid-Atlantic states, is showing growth. Container shipments both into and out of the ports of Los Angeles and Long Beach--key measures of international trade--have traced a V-shaped recovery.

In the financial markets, the yield on the 10-year Treasury note is back up to 3.86%, almost exactly where it was in August 2008, just before the crisis hit. The VIX Index--a measure of stock market volatility and risk--has also traded back to levels not seen since August 2008. Meanwhile, key commodity prices, such as oil, copper, lumber and gold are well off crisis-period lows.

In general, the economic scene is quickly returning to where it was in September 2008, just prior to the collapse of Lehman Brothers and the ensuing sudden slowdown in monetary velocity. True, the official arbiter of U.S. recessions, the National Bureau of Economic Research, says the recession started in December 2007. But we think that had it not been for the events of September 2008, a recession never would have been declared at all.

In the last full calendar quarter before September (the second quarter of 2008), real gross domestic product grew at almost a 3% annual rate. Now, after a second quarter in which real GDP has been kept negative by rapidly falling inventories, an annual growth rate of 3% is exactly what we expect for the third quarter of 2009, with even faster growth in Q4 and then in 2010.

With Treasury bond yields and the economy returning to pre-panic levels quite quickly, investors are left wondering about stocks. Will they return to September 2008 levels of roughly 11,000 on the Dow and 1,200 for the S&P 500? And if they do, how long will it take for them to get there?

Short-sellers, and many money managers who were not ready for the nearly 40% rally of the past three months, keep arguing that the stock market will go back to test its lows. Or, they think a sharp correction is in order. But this is more of a wish than a forecast. Any short-seller who did not unwind short positions and any long manager who was not fully invested in March has taken a hit. The only way to climb out of that hole is for the market to offer lower prices to those who missed them.

But having many investors in this position of having missed the rally makes a re-test of the lows less likely. This rally will not be over until the short-sellers fully capitulate. In fact, we expect to see one or two major short-selling hedge funds blow up and liquidate before the rally comes to an end.

As this unfolds in the months ahead, the stock market should rise back to its pre-panic levels. It took seven months for the Dow to fall from 11,000 to 6,500, and it is very possible that it could go back to 11,000 in another seven months. However, this would be unprecedented. A more reasonable forecast is that it will take until mid-2010 for stock prices to rise back to levels last seen in September 2008.

Brian S. Wesbury is chief economist and Robert Stein senior economist at First Trust Advisors in Wheaton, Ill. They write a weekly column for Forbes.