Hmm ... tastes like recession

Wall Street was buoyed by the GDP report. But consumers still aren't spending. And until they do, investors may have to be wary of the recovery talk.

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By Paul R. La Monica, CNNMoney.com editor at large

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Stocks have enjoyed a huge pop since early March. Some experts think the markets are heading even higher but others worry that investors have priced in unreasonble recovery hopes.

NEW YORK (CNNMoney.com) -- Score one for the green shoots crowd. The second-quarter gross domestic product report Friday clearly showed that the economy is in fact stabilizing.

For the most part, stocks finished the day slightly higher on the GDP news -- a bit of a surprise considering that investors had appeared to already factor in that the nation's gross domestic product probably shrunk at a much lower rate than in the previous two quarters.

A big sell-off wouldn't have been shocking since the S&P 500, after all, has surged more than 45% since early March.

So even though it's premature to give the economy a clean bill of health and say the recession is really over, many financial experts said it is growing increasingly difficult to be negative about the outlook for the economy and markets.

"There is still a lot of momentum in the market so I wouldn't be surprised to see stocks move higher over next few weeks," said Robert Phillips, co-founder of Spectrum Management Group of Raymond James & Associates, a money management firm in Indianapolis. "The world's not going to be fixed overnight but we're headed in the right direction."

Phillips said that one number in the report that really stood out to him was the drop in business inventories. Companies slashed inventories by $141 billion in the second quarter -- an acceleration of the $114 billion rate of decline in the first quarter.

Because of these actions, Phillips thinks that many businesses are now probably so lean and mean that they do need to start preparing for an eventual recovery. So that could mean that the job market may finally improve before long.

"We could be at the beginning right now of seeing staffing increases from businesses," Phillips said. "Companies have to start rebuilding their inventory and production could start rising in the third quarter."

Still, consumers don't appear to be convinced just yet that the worst is over. Many are still hunkering down and adding to savings instead of spending. Personal consumption expenditures dipped at a 1.2% rate in the second quarter.

And with the unemployment rate currently at 9.5% and widely expected to rise above 10% before long, the average American many not care if the recession is nearing an end.

"Although the recovery is about to begin, it is a technical recovery. The economy will be growing, but growth will be so modest that 70% to 80% of the population won't notice it," said Bill Hampel, chief economist for the Credit Union National Association. "The unemployment rate is not going to improve for some time so it will look, feel and taste like a recession well until next year."

Talkback: Do you plan to spend more in the second half of the year than you did in the first six months? And if you're saving more, what are you cutting back on? Leave your comments at the bottom of this story.

But it's possible consumers may start to feel better even if the job market doesn't take a turn up until 2010. That's because a combination of people being more responsible savers and signs of a bottom in the housing and stock markets might have a big impact. To that end, disposable income rose at a 4.6% rate in the quarter to $121 billion.

"There could be a wealth effect from housing prices stabilizing and the stock market rally," said Burt White, chief investment officer with LPL Financial, an independent broker-dealer in Boston. "If consumers just spend some of that $121 billion, not all of it, then you could get some good surprises in the economy in the third and fourth quarter of the year."

Somebody's spending: Too bad it's Washington

That is a big "if." For now, it appears that government spending is helping to compensate for the consumer slowdown. Total government spending rose at a 5.6% clip in the quarter and federal spending increased at a whopping 10.9% rate.

Time for my Mr. Rogers impersonation. Can you say stimulus and bailouts, kids? I knew you could.

Make no mistake. That is unsustainable, not to mention potentially damaging to the economy if the spending leads to a further weakening of the dollar, higher interest rates and runaway inflation.

"The government can't keep spending at this rate. Businesses and consumers need to pick up spending for the long term," White said.

Now, of course, consumers shouldn't start spending like sailors on shore leave again, or that could lead to new credit bubbles forming that could one day lead to another brutal recession.

But if consumers don't show some signs of life in the third and fourth quarters, pessimism about the recovery and stock markets could quickly return.

And considering that the revisions to GDP that the government announced Friday showed that the recession actually was even deeper than first believed, it's understandable if consumers decide to stay in bunker mentality mode for awhile longer.

Max Bublitz, chief strategist with SCM Advisors, a money manager based in San Francisco, said the economy is still not gaining much traction just yet. He added that the rally could fizzle if people start to think that a sharp, so-called V-shaped recovery isn't in the cards after all.

"Consumers are doing what you'd expect, spending less and saving more. The government is trying to pick up some of the slack," he said. "But we could have a problematic second half of the year if people realize that this may not be a V-shaped recovery after all."

Karl Mills, manager of the Counterpoint Select fund, added that people need to look at the forest beyond the green shoots. And he thinks that this forest is a nasty little thing called debt.

He said that increased levels of government and private debt will act as a brake on consumption. As such, he's worried that the stock market is way ahead of where it should be in this stage of a possible recovery.

"The stock market is starting to write checks that the economy is going to have a tough time passing," Mills said. "This was not a typical downturn. It will not be a typical recovery."

Talkback: Do you plan to spend more in the second half of the year than you did in the first six months? And if you're saving more, what are you cutting back on? To top of page

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