Stocks rally as odds of double-dip recession get downgraded

By Adam Shell, USA TODAY

NEW YORK — Thanks to better-than-expected economic data in the past two weeks, investors have downgraded the odds of the dreaded double-dip recession, paving the way for rallies in seven of the first eight trading days in September — historically the worst month for stocks.

The September rally — after the worst August performance since 2001 — raises a key question for investors, especially those who have been reluctant to embrace stocks for fear they'll crumble under the weight of slowing economic growth: How will stocks react if the economy doesn't relapse?

Quite well, based on research done by David Bianco, chief equity strategist at Bank of America Merrill Lynch. Bianco went back to 1960 to see how stocks fared after the Institute for Supply Management's manufacturing index fell below 50 — a reading below 50 signals economic contraction — but the economy did not fall into a recession. He found that "near-miss recessions" occurred in 1967, 1985, 1995, 1998 and 2003. The Standard & Poor's 500 index posted average gains of 15.2% in the September through January period following those five instances. The biggest gain: 1998, when the S&P rose 34.5% in the five-month period.

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"A 15% short-term return would not be inconsistent with history, provided we avoid a significant double dip," Bianco wrote to clients.

Until the recent rally, stocks had been in a downtrend since late April, as data on housing, jobs and manufacturing started to weaken, sparking double-dip fears. The softness caused some economists to raise the odds of a double dip to as high as 40%.

But the tide turned on Sept. 1 when the ISM manufacturing index of 56.3 for August beat estimates, the first of a mini-wave of better-than-expected data. Initial jobless claims have fallen two straight weeks. The August jobs report topped forecasts, as did pending home sales.

The economy's recent resurgence has turned billionaire investor Warren Buffett, CEO of Berkshire Hathaway, bullish on the U.S. economy. In remarks to the Montana Economic Development Summit on Monday, Buffett, according to Bloomberg News, said: "We will not have a double-dip recession at all. I see our businesses coming back almost across the board."

But not everybody on Wall Street thinks the economy is rebounding strongly. "We remain unconvinced there has been a change in the trend of below-potential growth," Barry Knapp at Barclays Capital told clients over the weekend. The consumer remains a big drag on the economy, he says. Despite the Dow's 5.3% rise this month, its best September start since 1939, Knapp says "the next significant move" in stocks is most likely down.

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