With the recent flood of economic data slowing to a trickle and second-quarter earnings results not expected to start flowing until mid-July, the sluggishness that has characterized equity trading for the last few weeks is likely to continue this week, analysts say, as traders mark time until the Federal Reserve announces its decision on short-term interest rates on June 30.
In fact, June 30 has become something of an obsession on Wall Street.
On that day, the Fed’s policy committee is expected to raise interest rates for the first time in four years by a quarter of a percentage point, and the U.S.-led coalition in Iraq will hand over authority for governing that country to a sovereign government. Both events are hugely significant for the U.S. economy, the situation in the Middle East and, ultimately, the U.S. stock market.
Wall Street has been on tenterhooks ahead of the date. The stock market has been locked in a narrow, low-volume funk over the last few weeks, with trading volume on the New York Stock Exchange consistently below the daily average. Concerns about increased terrorism in the Middle East as the handover day nears, the anticipation of a higher interest rate environment and sharply-higher oil prices are some of the key factors that have conspired to keep investors on the sidelines of the stock market, analysts say.
“Add to this that fact that stocks are up substantially from where they were just over a year ago, and the fact that they have rallied quite a bit from their lows in May this year,” said A.C. Moore, investment strategist at Dunvegan Associates. “So we are seeing some real hesitation here,” he added.
Another fixation for traders has been the possibility that central bankers will raise rates by more than a quarter point at their two-day meeting on June 29 and 30. That view was dispelled last week by two relatively benign inflation reports and a decline in oil prices. Another comfort for investors: Fed Chairman Alan Greenspan's reassurance that interest-rate rises are likely to be gradual.
Focus on earnings outlook
With the Fed’s actions more or less known, the pressing issue for the market now is the outlook for corporate earnings in the second half of the year, said David Joy, capital markets strategist at American Express Financial Advisors.
The view of some market mavens is that the second quarter of 2004 saw the peak in earnings growth, which has been robust for a number of quarters, and that the Fed’s rate hike in late June will trigger a deceleration in earnings growth in the second half of the year, pressuring stock prices. Others believe that if the momentum now seen in the economy can continue into the second half of the year, it may sustain company earnings, which could surprise on the upside.
“Right now, the majority view is that the economy will likely plateau in the second half of the year and so we have probably seen the best of earnings growth,” said Joy. “But my instinct says the economy will end up being stronger than expected and so we’ll continue to get pretty good momentum on the earnings front.”
One symptom of a decelerating earnings environment is a rotation from smaller-capitalization, high-beta stocks into larger-cap stocks -- a defensive move that started in the second quarter of 2004, said Joy. “Eventually, it’ll be time to get more defensive, and maybe we’ll get there some time in the second half, say in six months from now, but I don’t think it’s time to do that yet,” he noted.
Early estimates show second quarter earnings shaping up to be impressive, with the tally of company pre-announcements to date giving no indication of any negative surprises according to earnings research firm Thomson First Call. By the end of earnings reporting season, First Call expects earnings for companies in the Standard & Poor’s 500-stock index to be up 26 percent.
Dearth of economic data
This week’s platter of economic data is expected to be meager, with only reports on durable goods orders, new home sales, gross domestic product and consumer sentiment to sustain investors.
The data are expected to paint a picture of a stronger economy, but are unlikely to shake the market’s belief that the Fed will raise rates by a quarter percentage point when its policy committee meets in late June.
Events in Iraq are likely to overshadow any economic news, noted Peter Cardillo, chief market analyst and chief strategist at SW Bach. "The market is probably going to continue to focus on events in Iraq," he said, adding that if attacks begin to lessen, the market will turn its attention back to the economy.
Durable goods orders will be the most closely followed piece of data according to Scott Anderson, senior economist at Wells Fargo. Anderson is predicting a May rebound after a drop in orders in April. “Lots of people think last month was a blip after a strong number the month before, so the data will be looked at closely,” he said. “But if the number is weak, some will worry that manufacturing is winding down.”
Other data of note this week include a second revision of first-quarter gross domestic product, or GDP, which Anderson thinks might be revised up to 4.5 percent from 4.4 percent. And Friday's University of Michigan consumer sentiment survey is expected to inch higher, some economists think, as the stronger economy gives people more confidence in employment prospects.
Wall Street will also have a handful of earnings reports to mull over from investment banks Morgan Stanley and Goldman Sachs. Investors will also take the pulse of the consumer from reports due from retailers Walgreen, the largest U.S. drugstore chain, and retailer Family Dollar Stores. FedEx, the world's number-one air-express shipper, will give further indication about consumer and business strength on Wednesday when it reports quarterly figures.