The month of March marks the anniversary of the market’s near yearlong rally, but Wall Street is not in a party mood.
The reason for investors’ dismay: After an 11-month ascent from a multi-year low seen on March 11 last year, equity markets have spent the last four weeks essentially treading water, despite the strongest earnings season for 10 years and evidence of continued strength in the U.S. economy.
This week, as investors examine a fresh batch of economic data, including a key report on the U.S. job market, they will also be asking why stocks are floundering and what exactly is ailing them.
But most stock market observers, like Peter Dunay, chief strategist at Wall Street Access, a retail brokerage, say there isn’t one particular reason for the market’s funk. “We’re really between a rock and a hard place in the market right now,” he said.
“We’re seeing a little bit of job growth, the economy is growing nicely and interest rates are still low, so things are still on the positive side of the ledger, but investors are asking how much optimism should be priced into this market, and as there’s already quite a lot priced in, I think the right thing to do here is to be cautious,” Dunay added.
After soaring for 11 months, the Standard & Poor’s 500-stock index, a closely-followed measure of U.S. stock market performance, finished Friday — the last trading day of February — with a gain of just 14 points.
Other indices have struggled. The blue-chip Dow Jones industrial average saw its second week in the red last week, while the technology-focused Nasdaq Composite index fared even worse, recording its sixth straight week of declines.
But all three indices are showing a gain for 2004, and they have moved up sharply since the latest stock market rally began on March 11, 2003. The S&P 500 index is up over 40 percent, while the Nasdaq Composite has rallied a whopping 60 percent.
“Valuations on the Nasdaq are extremely stretched,” explained Dunay, pointing to a slow rotation into more conservative stocks. “Money is coming out of riskier technology stocks and into more secure names because people are saying if I’m in this sector, I’ll play safe.”
Dunay sees the Nasdaq’s six-week pull-back as more of a modest consolidation than a serious market correction. Aside from a 58-point decline in the week the index hit a 31-month high of 2,153.83 on Jan. 26, the Nasdaq’s weekly declines have been very small, he said. “We’ve only been down about 10 points each week, so it’s really moderate.”
Morgan Stanley market strategist Byron Wein has identified a number of “serious dangers” lurking ahead that may lead to a much-anticipated correction in stock prices, including overly bullish investor sentiment, a "disconcerting" pick-up in merger and acquisition activity and the beginnings of a shift into larger-capitalization stocks.
“It is widely believed that the market is overvalued,” Wein wrote in a recent note to investors, adding that “changes in leadership often coincide with a period of market softness.”
But Wein also noted that a stock market correction, which is likely to cost the broader market about 5 percent of its value, will probably be followed by another climb to new highs. “I still strongly believe 2004 will be another good year for equity investors,” he wrote.
Other market strategists see Wall Street’s recent funk as more of an orderly consolidation after a huge run-up than the beginning of a major decline in stock prices. "The market seems to have run out of steam,” said Peter Gottlieb, president of Gottlieb Investment Management in Chicago. “But the trend is still higher."
A more significant economic worry for Wall Street is the lack of employment creation, which makes this Friday’s release of the February jobs report a crucial event for investors.
The thinking on Wall Street is that unless the U.S. economy starts creating large numbers of jobs in the next few months, consumer spending will slow and so will economic growth, potentially damaging stock prices.
Steve Stanley, chief economist at RBS Greenwich Capital in Greenwich, Conn., expects to see a February payrolls increase of 145,000.
“It’s not as aggressive as other Wall Street economists are looking for, but after a disappointing couple of months I have scaled back my estimates,” Stanley said. “I think employment will grow gradually over the next few months and we’ll start to see healthy job growth by the middle of the year.”
After December and January failed to show the sort of job growth economists expect to see in a growing economy, some on Wall Street are worried about the specter of a jobless recovery. Another poor showing for the month of February could send stocks lower Stanley said.
“I don’t think the stock market would take it well initially, but it’s really a tough call,” he said. “If you’re not seeing decent job growth that implies economic weakness, but if businesses can get by with fewer employees, that’s a positive for profits. So the initial knee-jerk reaction will probably be bad, but then the market may rethink its response to the data because if productivity remains high profits will continue to surge.”
Other key economic reports due this week include data on personal income and spending for January, the Institute for Supply Management's report on manufacturing in February, U.S. car and truck sales for February, a mortgage and refinancing report and weekly initial jobless claims.
Reuters contributed to this article.