Nearly a year after the stock market began one of the biggest rallies in history, investors have begun to worry that this bull may be getting wobbly. There’s no shortage of cause for concern.
When last year’s financial meltdown sent investors hiding for cover, the market’s collapse was swift and ugly. When it appeared that the worst was over, stocks roared back with a 68 percent gain from March lows.
Now, with government stimulus fading, stubbornly high unemployment and the Federal Reserve signaling that interest rates may begin rising in a few months, investors seem to be having second thoughts.
Until a clearer outlook emerges, the market will likely remain stuck in neutral. Here are six market hazards to keep an eye on.
The greatest single force driving the price of a company’s stock is its profitability. The news on that front has been outstanding. More than 70 percent of fourth-quarter earnings reports from Standard & Poor's 500 companies came in higher than expected, according to Thomson Reuters data. Overall, profits have returned to roughly where they were before the recession began.
But that's all history. On Wall Street, stocks trade on the prospects for future profits. And it's not at all clear whether the profits we saw in the fourth quarter are sustainable. The gains follow a historic round of layoffs and other cost-cutting combined with massive government stimulus spending and a flood of money from the Fed.
That means companies have been squeezing more profit out of each dollar of sales. Now, investors are looking for convincing signs of growth in those top line sales numbers. And many say they're just not seeing it.
"People, I think, are in a sour mood," said Bob Doll, chief investment strategist at Blackrock, an asset management firm. "They're looking at the glass as half-empty. I think we're going to have to show them some good news to get moods improving."
Recent data on consumer sentiment show just how bad the mood is. On Tuesday, The Conference Board reported that its consumer confidence index dropped sharply to a 10-month low in February after advancing for three months. Worries about the job market were a big reason for the drop, the group said.
The good news everyone is waiting for will have to come from economic data. For the time being, investors are still waiting.
On Thursday, the market sold off on news that new unemployment claims rose more than expected in the latest week and durable goods orders last month were disappointing. On Wednesday, the government reported that the annual pace of new home sales in January plunged to a record low of 309,000 units.
"The data we've seen over the last couple days certainly does not look good," said Warren Meyers, CEO of Wall Street trading firm Walter J. Dowd. "The jobs numbers today was very weak. The housing number yesterday was horrible."
That's a sharp reversal from a string of positive economic data in the second half of last year that fueled market euphoria as the government’s huge spending effort began to restart growth.
The housing market perked up after tax credits were handed out to home buyers; the Cash for Clunkers program helped spur car sales. The good news culminated in a preliminary report that the gross domestic product surged at an annual rate of 5.7 percent in the last three months of 2009.
But a closer look at the numbers has given some analysts pause. More than half the fourth-quarter GDP growth came from companies restocking inventories after slashing them to the bone last year. Overall demand for goods and services has yet to return to “normal” levels.
Wall Street's bulls argue that the economic momentum of the last six months — even it it was the result of a huge stimulus shot in the arm — is strong enough to get the rest of the economy moving ahead once that stimulus spending wears off.
"The vast majority of the information and data suggests we're well into a recovery here in the United States and globally," said James Paulsen, chief investment strategist at Wells Capital Management. "It's not likely to turn back."
No matter what the GDP data show, most investors will want to see solid evidence of a reversal of the massive job losses that have sidelined more than eight million workers since the recession began in December 2007. And that won’t come until government employment data begin showing net gains of 100,000 or so jobs a month.
"Either they're going to show up in the next couple of months or we're going to be talking about double-dip recession again," said Paulsen. "That's where the mentality is going to go."
Also unclear is whether the housing market has hit bottom and will get back on its feet this spring. Several factors could derail what appear to be early signs of a housing recovery.
One is the overhang of inventory from home foreclosures. Though inventory levels have begun to fall back to relatively healthy levels, some analysts warn of a large “shadow inventory” that isn’t showing up in the official statistics. With roughly one in three mortgage holders owing more than their house is worth, and unemployment near its highest level in a quarter-century, default rates are expected to remain high into 2011. So far, efforts by the government and lending industry to head off foreclosures just haven’t worked.
The housing market has also gotten major support from the Fed’s huge buying spree of bonds’ backed by home mortgages. The central bank has said it will suspend those purchases when the $1.25 trillion program ends next month. That could send mortgage rates higher. No one knows how high.
The stock market’s record run has also gotten a big boost from the Fed’s “zero” interest rate policy. More than the government’s $700 billion TARP bailout, the policy of letting banks borrow at record low levels has helped the industry repair the giant hole left on its books from the collapse of the housing market. Until there are clear signs the economy is solidly back on its feet, many professional investors expect the Fed to keep rates low.
But Fed policymakers have been signaling that the policy won’t last forever. On Capitol Hill this week, Fed Chairman Ben Bernanke sought to calm concerns over a recent increase in the "discount" rate offered to banks in need of emergency loans. Bernanke said rates would remain low for some time as a way to cushion the blow from high unemployment.
The Fed has also begun shutting down an alphabet soup of emergency lending programs set up at the depths of the financial crisis in 2009.
With one eye on the U.S. central bank, investors have the other on the tough choices facing European bankers, amid rising concerns that Greece may default on its government debt. Larger European countries like France and Germany are reluctant to bail out the free-spending Greeks until they see evidence of tough austerity measures. But a series of strikes in response to calls for wage cuts and tax hikes have cast doubt on those measures.
Opinion is split on the outcome. Bailing out Greece could simply encourage overspending by other Eurozone governments. But if Greece is allowed to default, the worry is that other heavily indebted European countries may not be far behind.
Europe's monetary stalemate also highlights a wider problem weighing on the Eurozone's unified economy as it struggles through the worst downturn since the region consolidated around a single currency a decade ago.
"The problem with a lot of the European countries is they don't have an independent way to stimulate their economies right now," said Jay Bryson, a global economist at Wells Fargo Securities. "Monetary policy is in the hands of the (European Central Bank). Most of their exports go to each other. They can't devaluate or depreciate their currencies. So you're looking at no way to stimulate the economy."
As a result of Europe’s financial strains, global investors have been selling the euro and buying the dollar, boosting its value.
A stronger dollar helps ease upward pressure on interest rates because it helps support demand for dollar-denominated U.S. Treasuries. But if you own stock in a large multinational company that does a lot of business in Europe, the drop in the euro's value dilutes profits when they’re converted back into dollars.
A stronger dollar could also hurt U.S. exporters to European markets, who will lose the price advantage against competitors.
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