????If you're looking for a recovery, says market-watcher David Kelly, the signs are starting to grow.

????By Beth Kowitt

????J.P. Morgan Funds Chief Strategist David Kelly said in a conference call Monday that he's not sure if the recent market rally is for real, but he feels more confident that an economic recovery is underway.

????"In the long-run, it's the economy that determines markets, not the other way around," he said.

????Truly unprecedented financial events got us where we are today, Kelly told Fortune after the call, but the economic environment we're seeing right now is not as unusual.

????"This is a more normal recession, oddly enough, than it is a financial situation," he said.

????Along with the release of his second-quarter "Guide to the Markets" report, he noted during the conference call that the huge increases coming in the nation's deficit are not unprecedented. The proposed budget for 2009 would create a 12.3% deficit of gross domestic product, but during World War II, the rate hit 30%. "That experience did lift us out of the Depression," Kelly said of the government spending.

????Pointing to indicators such as the housing market, he said it was a "hopeful sign in looking for a bit of a turnaround."

????Home prices are down, the inventory of new homes has fallen, and housing starts are incredibly low, he said. If you put average home prices and record-low mortgage rates together, he pointed out, you have housing that's as cheap as it's ever been.

????"One of the things that the average investor needs to understand is we're really starting to get beyond the housing bubble itself," he said. "The housing sector is really in a position to heal itself at this stage."

????Kelly also noted that some areas of the credit market are starting to mend. The TED Spread, which is the difference between the 3-month Libor rate and the three-month Treasury yield, peaked in October at 4.6 percentage points and fell to 1 point at the end of March. He said the drop indicates that banks are more willing to lend to other banks. While this shows some sign of improvement, he noted that we're "not quite out of the woods" because banks are still hesitant to lend to other businesses.

????Looking at broader economic indicators, Kelly said GDP growth is the worst in 26 years. But while he expects GDP to shrink in the first quarter, he said the second quarter could grow with cyclical sectors of the economy trending up.

????Kelly noted that the danger of inflation taking off because of the Federal Reserve's recent actions such as the bailouts are overstated, but he did say that that there are limits to what the central bank is trying to do. "The massive expansion of the reserves is having less impact than perhaps the Federal Reserve would like," he said.

????For investors, Kelly thinks there are "a lot of cheap long-term assets out there." He pointed to the Q-Ratio as a sign that stocks are cheap. A low Q-Ratio, which is a stock's price relative to the company assets, indicates that stocks are undervalued. It has fallen to 62.1%. The 40-year average is 78.2%.

????While there might be a temptation for people to regard international stocks as too risky, Kelly thinks they're cheap relative to U.S. stocks, with the U.K., Europe (excluding the U.K.), Japan, and Asia (excluding Japan) all showing price-to-earnings ratios lower than the U.S. “

????But in the bond market, Kelly said 10-year treasurys are too expensive, with the most recent real 10-year yield at 0.90%, while the 20-year average for real 10-year treasurys is 2.93%. He might not be a fan of that part of the fixed-income market, but he does like corporate bonds, which have high yield-spreads of 15.4%.

????Kelly noted that last year was terrible for all investors, but a diversified portfolio - which he defines as a mixture including of the Russell 1000 Value, Russell 1000 Growth, Russell 2000, and the Barclay Capital Aggregate - would have dropped about 24%, By contrast, the S&P 500 index fell 38.5% in 2008, while the Dow Jones industrial average dropped 33.8%.

????"We want to make sure in a world where people are extremely short-term in their investment behavior," he said, "we just want to put in a plug for sensible long-term investing because we think sensible long-term investing can win out from this point."