While on a trip down the Ukraine’s Dnieper River in 1787, Russia’s Empress Catherine II was impressed by the sight of picturesque, prosperous villages along the riverbank. Problem is, behind the nicely painted facades were decrepit buildings. The deception was engineered by Catherine’s minister and lover Grigory Potemkin.

The stretch of countryside was actually faring poorly, but Potemkin wanted to give her royal highness the impression of economic well-being. Potemkin’s henchmen, garbed as peasants, would “populate” the villages. The ruse apparently worked, but the widespread poverty remained untouched. The historical incident gave rise to the lasting term, “Potemkin Village.”

Which brings me to the current U.S. “recovery” that’s cheering investors and fueling the stock market rally. I call it the Potemkin Recovery.

Investors are thrilled by the appearance of economic turnaround. The S&P 500 has soared almost 40% since March 23, its fastest advance since 1933 (more on that milestone, below). The tech-heavy NASDAQ composite has erased all of its losses since the coronavirus low.

Stocks extended those gains on Monday. The Dow Jones Industrial Average jumped 1.70%, the S&P 500 climbed 1.20%, and the NASDAQ rose 1.13%. As of this writing Tuesday morning, the three main indices were taking a breather and trading in the red.

The grand illusion…

I discussed the illusion of massive jobs growth in my article yesterday: The “Creative Accounting” Behind the Rally. The topic warrants further amplification.

You can slap paint on the outside of a building but it doesn’t mean the structure is fundamentally sound. That’s the situation with the latest U.S. jobs report, which showed the unemployment rate falling on a huge and unexpected jobs gain in May.

But if you actually read the report, you’ll notice a note from the Bureau of Labor Statistics, acknowledging a “misclassification error” that resulted in the reported unemployment rate being lower than it actually is. Based on the BLS’s estimates adjusted for the misclassification error, the unemployment rate dropped from 19.5% in April to 16.4% in May.

In its latest press release, this is how the BLS explained the mistake:

“In the household survey, individuals are classified as employed, unemployed, or not in the labor force based on their answers to a series of questions about their activities during the survey reference week (May 10th through May 16th). Workers who indicate they were not working during the entire survey reference week and expect to be recalled to their jobs should be classified as unemployed on temporary layoff.

In May, a large number of persons were classified as unemployed on temporary layoff. However, there was also a large number of workers who were classified as employed but absent from work. As was the case in March and April, household survey interviewers were instructed to classify employed persons absent from work due to coronavirus-related business closures as unemployed on temporary layoff. However, it is apparent that not all such workers were so classified.”

The following chart tells the story:

In today’s media circus, the sound bite is remembered and the fine print is either never acknowledged or quickly forgotten. With this jobs report, an alternate reality has been created that financial media are pushing, to manufacture a bullish consensus. I watched CNBC this morning (an act that I always come to regret as a waste of time) and the coordinated message was: “We’re back, baby!”

In my opinion, we’re far from back. According to research firm FactSet, analysts predict a year-over-year decline in corporate earnings in the second quarter (-43.1%), third quarter (-24.9%), and fourth quarter (-12.5%) of 2020. Investors who expect earnings to come in better than feared should know that analysts are revising expectations downward.

During the first five months of calendar year (CY) 2020, analysts lowered earnings estimates for companies in the S&P 500 for the year. The CY 2020 bottom-up earnings per share (EPS) estimate plunged 28% (to $128.03 from $177.82) during this period. “Bottom-up” is an aggregation of the median 2020 EPS estimates for all the companies in the index.

Most economists predict that data for the second quarter will show U.S gross domestic product (GDP) contracted at an annual rate of 30% or more, a level that conjures images of the Great Depression of the 1930s. The Congressional Budget Office (CBO) projects that the economy won’t return to its pre-pandemic level until 2022 at the soonest. The CBO is non-partisan, highly respected, and boasts an excellent track record.

By temperament I’d rather be on the bullish bandwagon, but my job is to deal in the facts and not deception. Hope is not a wise investment strategy. You should stay invested, but with your eyes open.

Another crash is probably on the way. At the top of this story, I alluded to the year 1933. That should make you sit up and take notice. The bear market of the Great Depression witnessed several sharp rallies that all came to heartbreak.

We’ve put together a special report that explains why (conventional) stocks could drop another 31% over the near term. But here’s the good news: This report also pinpoints a class of all-weather stocks that can provide growth, safety and income, even in down markets. And that’s no illusion. Click here for details.

John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com