Monday, 3 August 2009

Stocks rally, economy could follow

The United States economy may be set to begin recovering soon.

On Friday, the US Commerce Department reported that real gross domestic product shrank at an annualised rate of 1.0 percent in the second quarter, much better than the 6.4 percent rate of contraction in the first quarter. This confirms the view of many economists that the economy has seen the worst of the recession and may be turning around.

The stock market's performance in the past few months supports this view. On Friday, the Standard & Poor's 500 index closed at 987.48. This is 46 percent higher than its closing low of 676.53 on 9 March, suggesting that the stock market has made a cycle low.

The accompanying chart shows that during recessions, a bottom in the stock market is usually followed by a bottom in the economy.

Of course, we cannot be sure yet that a bottom has actually been made in the stock market. There have been some suggestions that the current rally in the stock market is only a bear market rally and that stock prices are likely to resume their downtrend soon.

Nevertheless, it is interesting to note in this respect that during the previous recession in 2001, even the false market bottom made in September that year was followed soon after by an economic recovery, albeit a weak one.

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