What might be in store when government supports have run its course?

So far in the first two months of 2010, the stock market performance looks eerily similar to what happened during June and July of 2009: It ran up and then drop abruptly for nearly 10% before it recovers rapidly.

There are a lot of well-supported pessimism in the market sentiment: Housing is still in a slump, more foreclosures are on the rise, there may be anywhere from 3 million to 7 million "shadow inventory" of homes in or near default that are on their way to foreclosure over the next couple of years. Unemployment is going to stay near 10% for at least the rest of the year. Consumers are tapped-out or shell-shocked to spend. They're saving more, which is going to limit the GDP growth. Government's deficit spending is a painful medicine. Where are the trillions of dollars are going to come from? The unavoidable tax increase is going to suck the life out of consumer spending and corporate spending if the federal deficit is to be dealt with...... All powerful dark forces.

The stock market and the leading inconomic indicators however are pointing to a much more bullish picture. Manufactoring is picking up steam, helped not just by inventory restocking. Export is surging. Technology sector has been strong. Retailers have seen improved results... not to mention that credit market has stabilized, banks are making money and may be on the verge of increasing their lending activities, even the housing market seems to have shown some signs of recovery, home builders and home improvement companies have seen improved earnings and sales.

When the stock market was rebounding powerfully last year, investors were focusing on normalization trades, betting that corporate profits would be protected. Companies moved aggressively to cut costs. Profit surged, at the expense of millions of unemployed. Many questioned how long that can last with out improving revenue. Well, so far in this earnings season, nearly 68% of companies reported fourth-quarter profits that beat estimates, while 71% topped revenue targets. Clearly the results are not all coming from cost cutting anymore.
Question remains though, how much of that improved profitability and sales is the result of government supports? And hence can this uptrend continue when all the government supports have run its course?

Investors will have to find an answer or take a position on this critical question.

We will continue to look for signs in the real economy for cues of a sustainable recovery. Financial sector is all important, but by itself recovery will not happen. The sector looks ready to provide the necessary fuel, should the real economy starts to pick up.