IMPORTANT STATISTICS AHEAD From David Kelly, chief market strategist, JP Morgan Funds

After a two-month rally in the stock market, investors this week may be looking for more definitive signs that the economy is beginning to find a bottom.

Surveys of consumers and businesses seem to be pointing in that direction with big gains in consumer confidence measures and the ISM manufacturing index last week.  However, in the most critical cyclical areas of the economy, vehicle sales actually relapsed in April, while mortgage applications to purchase homes are seeing only halting gains despite record low interest rates.

Monday’s pending home sales index will be important as an indicator of any pickup in housing while the ISM Non-Manufacturing survey will be examined to see if it matches the gains seen in manufacturing surveys.

The markets may well shrug off a second consecutive quarter of slightly negative productivity growth – productivity is supposed to be cyclical and will very likely bounce back as the economy improves – perhaps as early as in the current quarter. However, harder to dismiss will be another shockingly ugly jobs report with the possibility of more than 700,000 jobs lost and the unemployment rate potentially rising to 9.0%.

TURNING THE CORNER From Tom Sowanick, chief investment strategist, Clearbrook Financial

We find the increase in risk appetite is undeniable at this time and spread across many asset classes. The S&P 500 has gained 25% since March 9th which is identical to the 25% earned with the emerging market BRIC basket. However, the similarity of returns disguises the fact that the BRIC Index has gained 13.8% since the start of the year versus a loss of 5.78% for the S&P. The difference in the YTD performance suggests that investors were already in the early stages of elevating their risk appetites, at least outside of the U.S.

 In the bond market, we can see a similar pattern of performance, with the lowest credit qualities providing the highest returns and the highest quality sector producing the worst returns. The high yield market has now gained 11.8% for the year, which far exceeds the 4.8% lost by holding 10-year Treasury notes. The convertible bond market has also produced strong results by gaining 11.6% on a YTD basis with most of those gained occurring since early March.

We are also now beginning to see signs of either economic stability or a deceleration of negative economic activity. Perhaps the most important reading has come in the consumer confidence data which reveals that consumers are very constructive about their outlooks six-months forward despite the fact that their current readings of confidence remains quite low. Consumer spending seems to be stabilizing and housing activity seems to have bottomed, with existing home sales reaching bottom in January with an annualized sales pace of 4.49 million units versus the 4.64 million unit average of the past two months.

Despite the recent market strength across many asset classes, investor sentiment remains cautious, which in our view is a positive development. Cautious optimism will keep pent-up demand high, as many investors will continue to wait on the sidelines until either the market moves still higher or economic data develops a more positive and sustainable trend.

WATCH OUT FOR A VALUE TRAP From Charles Biderman, chief executive officer, TrimTabs Investment Research

Companies and corporate insiders have not joined the party on Wall Street. Since March 9, the float of shares in the U.S. stock market has increased $14.1 billion. In April, corporate insiders sold $2.1 billion, 14 times more than the $150 million they purchased.

Retail investors have shown some enthusiasm for U.S. stocks. U.S. equity funds posted inflows in each of the past five weeks totaling $12.4 billion. But even if retail investors pumped $12.4 billion into U.S. equities directly in the past five weeks in addition to the $12.4 billion they added to U.S. equity funds, their buying would not have been enough to drive stock prices up so much.

Since corporate America has been a net seller and retail investors have been moderate net buyers, institutional investors must have provided most of the fuel for the rally. The latest Barron’s Big Money Poll suggests institutional players have turned very upbeat. A whopping 59% of respondents describe themselves as bullish or very bullish, while only 13% of respondents describe themselves as bearish.

Institutional players apparently believe they are catching the bottom of the economy and the stock market. The problem is that consumer spendables will drop an estimated $55 billion in May 2009 relative to May 2008. The decline will be so severe due mostly to the impact of tax credits. While the “Bush” tax credit distributed $48 billion in May 2008, we estimate that the “Obama” tax credit will distribute only $7 billion in May 2009.

To add to this cheery picture, incomes of all types are plummeting.  ncome tax withholdings dropped an adjusted 6.1% y-o-y in the past three weeks and four days, which is consistent with monthly job losses of at least 550,000, and non-wage income and corporate income are in a free fall. The latest data on chain-store sales, automobile sales, and savings flows all suggest that the economy’s green shoots are already dying. When portfolio managers realize that the economy is sinking, the tape will turn very ugly.

IS DEBT THE NEW EQUITY? From Charles de Vaulx and Chuck de lardemelle, IVA Funds

Apropos bonds, Chuck believes that the sweet spot is in the quasi-or low
investment grade bonds rated BB to BBB yielding double digits, rather than the true junk (B and below) yielding 20 to 40% but where defaults will be very substantial, and hence the downside risk may be too great for us to stomach. “Corporate debt (ex financials) as a percentage of GDP in the US has crept up from 25% in the mid-1950’s to 50% today. It is much less than in the 1930’s, but a post-war high, and up from less than 40% in the mid 90’s. This leads us to be careful with P/E valuations: companies are more leveraged today than they were during the nasty 1973-74 bear market or the 80’s when the bull market started,” he adds. In some cases today, the leverage is so high in relation to depressed earnings that the equity really has become more like an option, while the high yield bonds or bank loans may be yielding 15% to 40%. In essence, the debt has become the equity, while the equity is a speculative call option. In some cases indeed, the debt will formally become equity through the bankruptcy process. The call option will expire worthless… This leads de Vaulx to conclude, “In a market like this, perhaps debt is the new equity.”

“Less Bad” does not equal “Good” From Stephanie Giroux, Chief investment strategist, TD Ameritrade

Recovery from near-record lows on all sorts of economic indicators has generally failed to emerge, and we believe the up-slope back to “normal” GDP growth of about 3% is still far off on the horizon.

• GDP forecasts highlight the need to be able to “go the distance.” First-quarter GDP fell at a -6.1% annual rate, slightly bettering the final fourth-quarter annual rate of -6.3%. By comparison, GDP has averaged 2.8% since 1980. And forward expectations shown below indicate that, while GDP will likely stop declining by the third quarter of this year, we will not see a return to “normal” GDP growth until at least 2011. This muted recovery forecast is supported by the fact that consumer spending is likely to stay weak for awhile. At its peak, personal consumption contributed 71% of GDP in 2008, compared with a long-term average of 65%.

• High unemployment will continue to curb consumer income growth and spending. The equity market seems to have priced in anticipation of a 10% peak unemployment rate later this year or early next year. But our research suggests that stocks will have difficulty reversing their bearish trend until peak unemployment becomes more certain and more importantly, begins to decline. In addition, consumers’ new found desire to save rather than spend will be reinforced by slow income growth that is kept in check by a stubbornly high unemployment rate and low near-term wage inflation.

• Corporate earnings may provide a bright spot later this year. Forecasts for the remainder of 2009 and 2010 continue to come down but are falling at a slower pace of late. And it would appear that corporate CEOs and CFOs are starting to guide the earnings outlooks to capture a “worst case” type scenario, perhaps just as the economy is hitting bottom. Many businesses have been quick to reduce both headcount and inventory levels in the forth quarter of 2008 and first quarter of 2009 to better align costs to a presumed on-going tough economic environment. And while these adjustments have contributed to volatility in the equity markets, this change in outlook may translate to investor benefits later in the year, if actual earnings stop falling and/or disappointing relative to forecasts. Such a development is needed to bolster investor confidence in economic recovery and sustain an upward trending stock market.