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Holiday dilemma for investors: party or panic?

After a forceful reminder that the third quarter is history, stock investors are now uneasy about the final months of the year.
/ Source: The Associated Press

After a forceful reminder that the third quarter is history, stock investors are now uneasy about the final months of the year.

Stocks posted their biggest losses in four months Friday as traders worried that consumers won't be able to help lift the economy. Only a day earlier, investors celebrated news that the economy grew at the fastest pace in two years in the July-September period.

The Dow Jones industrial average rose 200 points Thursday only to tumble 250 on Friday.

The market's volatility adds urgency to a flood of data this week that could help signal whether investors have been prescient or premature in the bets they've been placing on a rebound in the economy. The benchmark Standard & Poor's 500 index lost 2 percent for October to break a seven-month streak of gains but is still up 53.2 percent from a 12-year low in March.

Much of this week's data on employment, manufacturing, services and home sales will provide investors with more up-to-date snapshots of the economy than last week's numbers on the third quarter. The Federal Reserve also will weigh in after it wraps up a two-day meeting on interest rate policy.

The week may be pivotal because investors will searching for clues about how the country will stand without as much government hand-holding as in the third quarter, when the economy grew at an annual pace of 3.5 percent. Some programs like Cash for Clunkers that drummed up car sales and puffed up the overall economy have ended.

Traders also will be sifting through comments from the Fed for signals on when policymakers might start to raise interest rates, which are at essentially zero, a record low.

Investors will be looking under the hood of economic reports for any insight about what might happen in the final two months of the fourth quarter and in 2010. The Institute for Supply Management's October index on manufacturing is expected Monday. Analysts will be paying particular attention to its new orders index, which is an indicator of future activity. The ISM's index on service industries is due Wednesday.

The biggest report of the week is expected to be the Labor Department's October employment report. Unemployment stands at a 26-year high of 9.8 percent. Analysts predict unemployment will have risen for October and that it will top 10 percent by next year.

Even though unemployment doesn't tend to fall until well after economic recoveries have begun, some investors are worried that layoffs and the threat of layoffs will prove so severe that they will undermine the economy's ability to recover by keeping consumers away from stores.

Increased spending by households is considered key to a sustained recovery. So far, the economy's turn has come from government spending and businesses boosting profits by slashing costs.

Jill Evans, portfolio manager of the Alpine Dynamic Dividend Fund in Purchase, N.Y., said that even as consumers hold back, some businesses like manufacturers are doing better as overseas economies recover faster. The weak dollar makes U.S. exports cheap for foreign buyers.

"I think we're having a bit of a tug-of-war here," she said, referring to improvements among some businesses and lagging consumers.

Evans noted that consumers have been the ones to pull the economy out of recessions since the 1990s but that more often, increased spending by businesses and government is what plucks the economy from downturns.

"The consumer is expected, in our opinion, to be the last thing to turn here," she said.

Investors are focused on consumer spending because they know that companies can't keep turning profits by cutting costs. Eventually, revenue will need to pick up for companies to keep making money.

Third-quarter reports are in from about two-thirds of the companies that make up the Standard & Poor's 500 index and about eight of every 10 companies have posted profits that exceed expectations, according to Thomson Reuters. Revenue is improving but remains weak.

The surprising profit reports were enough to lift the market in September and the early part of October but investors have grown accustomed to better-than-expected results.

Ford Motor Co. is slated to report Monday. Investors will hear later in the week from networking equipment maker Cisco Systems Inc., Kraft Foods Inc., Marathon Oil Corp., Starbucks Corp. and Time Warner Inc.

Monthly sales figures are due from major retailers as well as automakers.

Curtis Teberg, portfolio manager at the Teberg Fund, notes that even with all the worries investors are facing, many of the problems are already well-known and priced into the market.

"When I look at the history and say 'OK, is this a safe time to be in the equity markets?' I feel comfortable that it is. I don't know how much more negative news we can get coming out," he said.

Teberg noted that stocks tend to do well in the final stretch of the year as investors look to dress up their portfolios. In the past 50 years, the combined returns of November and December have been positive 85 percent of the time.