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Stock market is betting economy is getting stronger

Traders work on the floor at the New York Stock Exchange, March 14, 2013.
Traders work on the floor at the New York Stock Exchange, March 14, 2013.BRENDAN MCDERMID / Reuters

It took a lot longer than anyone would have liked, but the recovery from the Great Recession is now firmly in place. At least, that's what investors in the stock market seem to believe.

The markets powered ahead again Thursday for the 10th straight day, the longest streak of winning days in more than 16 years, after another round of data pointed to continued improvement in the job market.

The Dow Jones Industrial Average rallied 83.86 points, or 0.58 percent, to end at 14,539.14. Hewlett-Packard and IBM led the gainers, logging its first 10th-consecutive winning streak for the first time since November 1996. The S&P 500 rose 8.71 points, or 0.56 percent, to close at 1,563.23 -- just short of its all-time closing high set in 2007. The Nasdaq gained 13.81 points, or 0.43 percent, to finish at 3,258.93.

The government reported that workers filed fewer new unemployment claims than they have in five years, echoing last week’s data showing that employers added a surprising 256,000 new workers to payrolls in February.

The improved outlook has been taking hold since the beginning of the year, when Congress and the White House averted a massive tax hike that threatened to snuff out an already-feeble recovery. Since then, a string of reports – from strong retail sales to a convincing pickup in the housing market – has prompted forecasters to boost their expectations for the overall pace of growth.

“We’ve grown for 14 straight quarters now,” said Brian Wesbury, chief economist at First Trust Advisors. “If you look at (these reports) they all show a picture that the economy in 2013 is stronger than it was in 2012.”

Other economic forecasters agree. JPMorgan analysts this week raised their forecast for this year’s growth in gross domestic product to 2.3 percent, up by eight-tenths of a percentage point. Goldman Sachs raised its forecast by three-tenths of a point to 2.9 percent.

Bill Gross, the influential co-chief investment officer of bond-giant Pimco, doubled his estimate to 3 percent in 2013.

Corporate CEOs also are feeling a lot better about the prospects for the new year. A survey this week by the Business Roundtable, whose members are senior managers of large U.S. companies, found that 72 percent of them expect sales to rise in the next six months, up from 58 percent who felt that way in December. Some 38 percent plan to boost capital spending on new plant and equipment, which will help boost sales for their suppliers.

Stock market investors are betting that those higher sales will fuel higher profits later this year, further boosting stock prices. Since last June, stock prices have surged by nearly 30 percent. And, like any extended run-up, gains like those tend to feed on themselves as investors on the sidelines become convinced the rally will continue.

The stock market’s panic button is at its lowest level in six years. The so-called VIX index, which measures investor's expecations about the market's volatility, has fallen to the lowest level since March, 2007, shortly before the Great Recession took hold.

There’s also plenty of money ready to invest. Americans are better able to put money in the stock market than they have been since the twin collapse of the stock and housing markets five years ago wiped out $16 trillion in household wealth. That financial hole has largely been filled in, according to the latest data from the Federal Reserve.

Households have also substantially paid down debt, which puts them in better shape to support continued growth in consumer spending, which accounts for more than two thirds of U.S. GDP.

But with memories still fresh of the massive, late-2000s debt hangover, and unemployment still at painfully high levels, no one is predicting a consumer-fueled boom just yet. Even as their finances have improved, consumers have kept a tight lid on new debt.

“Consumers are going through a lot right now,” said Dean Maki, chief U.S. economist at Barclays Capital. "We just had the tax increases which we think have not fully affected spending yet, and they faced large gas price increases in February. We think the consumer spending numbers - while they’ve been strong so far - are likely to soften a bit over the next few months.”

Government spending is also on track to soften later this year as the $85 billion in “sequester” budget cuts begins to take hold. A slowdown in government spending, which makes up roughly a fifth of GDP, is expected to hold back overall growth later this year.

Much depends on whether Congress and the White House can reach a deal to minimize the impact. Most forecasters expect the budget cuts to trim growth by as much as a full percentage point in the second half of this year.

Some investment advisers caution that the renewed optimism may be overdone, and that the stock market rally has gotten ahead of itself.

Traders work on the floor at the New York Stock Exchange, March 14, 2013.
Traders work on the floor at the New York Stock Exchange, March 14, 2013.BRENDAN MCDERMID / Reuters

While stock market bulls argue that the U.S. economy is in better shape than most people believe, some bears point to a global economy that may be weaker than widely understood. Though Europe seems to have avoided the painful break-up of its common currency, it remains locked in a stubborn recession.

“I don't believe the U.S., in this global economy, can effectively go it alone,” said Steven C. Cortes, founder of Veracruz, a research firm.”That's what the stock market has said so far, but I don't think it's sustainable. “

Despite recent upbeat signs in the U.S., the economy remains weaker than in past recoveries. Employers are adding jobs at the rate of about 200,000 a month, a pace that will only gradually make a dent in the current 7.7 percent jobless rate. Until the jobless rate falls below 6.5 percent, growth in the overall economy is expected to remain in the “slow, steady” range.

That 6.5 percent rate is also the employment level Fed officials are targeting for their “exit” from the biggest easy-money stimulus in the central bank’s 100-year-history. The current stock market rally has been fueled by record low interest rates, which virtually eliminate the return on safer investments like government bonds. Low rates have also encouraged businesses to invest and consumers to borrow to buy homes and cars.

The hope is that when the Fed eases off its easy-money policy and rates begin to rise, the underlying economy will be strong enough to weather the dampening effect of rising rates. That day is not expected to arrive until next year at the earliest.

If it comes any sooner, stock investors could be in for rude shock.