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Why
the Bull May Be Tiring
Thursday January 29, 11:57 am ET
Until
the Jan. 28 stock sell-off sparked by a subtle but unexpected policy shift expressed
in the Federal Reserve's post-meeting statement, 2004 had mostly been a continuation
of a stock rebound that began last March. The benchmark Standard & Poor's
500-stock index had been up 3% year-to-date as impressive corporate profits and
the recovering U.S. economy gave investors reasons to extend their buying spree.
The figures tell the story. For the fourth quarter of 2003, S&P 500 companies
are expected to show a 27% jump in year-over-year profits, making it the best
quarter in a decade, says earnings tracker First Call/Thomson Financial. With
48% of the companies having posted results so far, that increase is tracking at
more like 30%. With numbers like that, investors seem to have forgotten the
adage about buying on the rumor and selling on the news. The strength of profits
had convinced investors to keep adding stocks to their portfolios. Companies were
topping estimates by 5.3 percentage points on average. The historic beating-the-numbers
average is some 3 percentage points, according to First Call. FIZZLING FIESTA?
Says Jim Stanton, Washington (D.C.)-based chief editor of Low Risk Strategy, a
newsletter for retail investors: "This quarter, a lot of times, the earnings are
even better than the whisper numbers," referring to the unofficial profit estimates
that usually float among Wall Street analysts and are typically higher than published
guidance. Yet the market fiesta could be fizzling -- and not only because of
negative reaction to the Fed's post-meeting statement, say some Wall Streeters.
The central bank had made a nuanced shift in expressing how soon it may be considering
a hike in interest rates. While practically no one expects the market to drop
dramatically in the next few months, they predict that a mostly steady climb over
the past 10 months or so could turn into a less confident, up-and-down pattern
by summer, if not earlier. The latest quarter likely represents a peak in the
effect of fiscal and monetary stimulus resulting from Bush Administration tax
cuts and rock-bottom interest rates, says Chuck Hill, First Call's director of
research in Boston. As the Fed signals that it may nudge rates higher sooner than
expected, it's far from clear that the White House can convince Congress to make
current temporary tax cuts permanent. "The stimulus has peaked," Hill notes. MISSING
DRIVERS. Furthermore, as the federal budget deficit rises, pressure could mount
to hike interest rates to keep investors interested in U.S. bonds, which are a
primary means for Uncle Sam to raise capital. Typically, higher interest rates
translate into lower equities prices. "A lot of unresolved things out there could
go bump in the middle of the night at any time," says A.C. Moore, chief investment
strategist with Dunvegan Associates in Santa Barbara, Calif. "I really think markets
could soften between now and the end of the summer." The major indexes likely
will finish the year with respectable gains, but future profit gains are likely
to dwindle, removing one leg of the market's momentum. "We're looking at decelerating
earnings for the next three quarters," says Hill. Analysts expect corporate profits
to increase 13.8% year-over-year in the first quarter of 2004, 13.5% in the second,
and 10.6% in the third, First Call says. "That's a fair amount of fall-off" from
the unsustainable levels of 2003's fourth quarter, says Hill. With earnings
momentum slowing, "where are the fundamental mechanisms that are going to push
the market higher from here?" asks Paul Cherney, chief market analyst for S&P.
Cherney says the S&P 500 is bumping up against a resistance level of 1,151
to 1,176, and technical factors suggest "it's going to be very difficult for the
market to move appreciably higher in the next three weeks." Cherney adds that
he believes the market is overbought, which means stocks may have gotten a little
pricey. The S&P 500 is now trading at about 18.4 times 2004 calendar earnings,
above its historic price-to-earnings multiple of 17. ELECTION-YEAR GAINS. Decelerating
earnings growth might also be bad news for the hiring outlook. Economists had
hoped the labor market would be picking up by now and were banking on job creation
to help keep the economy humming. If the job market weakens again, it could derail
consumer spending, a key component of the recovery. Other macroeconomic trends
could also hamper the stock market's advance, warns Moore. Among them, a weakening
U.S. dollar, which has continued to fall against major foreign currencies, could
cause foreign investors to lighten up on dollar-denominated equities. Most
market watchers are forecasting another up year for stocks. A couple of historical
precedents suggest the S&P 500 could end 2004 around 10% higher. For starters,
it's an election year. In 9 of the 11 Presidential election years since 1960,
the market has finished positive for the year -- by an average of 9.69%. Though
little hard science exists to explain the phenomenon, if you're a candidate "you
have to be friendly to the markets," quips Cherney. WATCHING JANUARY. If stocks
manage to close out January higher, chances are good the rest of the year will
be positive, too, writes Jeffrey Kleintop, chief investment strategist with PNC
Advisors in Philadelphia. Since 1950, stocks have ended the year higher 74% of
the time when they posted gains in January, says Kleintop in a note to investors.
Those increases have averaged 12%, although Kleintop expects the market to advance
from current levels of around 5% for the remainder of the year. That would represent
an appreciation of around 8% in the S&P 500. If January ends on a negative
note, the year could end with losses of 1%, Kleintop warns, citing past performance.
Bottom line: Despite a bright start, 2004 may not match the 26% gains seen
in the S&P 500 in 2003 as the economy started its comeback. Nevertheless,
it'll still look a lot better than the losses suffered in the three-year bear
market that started this decade. | 
