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Trapped in a Downdraft

By Arnie Kaufman The market's malaise creates an environment in which worries flourish. Among factors cited as threats to the vigor of the economic expansion are still-underutilized plant capacity, which holds down capital expenditures; the heavy debt load of consumers, which limits their spending; the shortfall in U.S. Treasury tax receipts, putting upward pressure on interest rates; and the decline in the dollar, causing foreigners to shun U.S. assets.

But there's also a positive side that is being ignored because of the generally poor psychology. Excess capacity helps contain inflation. Consumer debt, though up, is not particularly high in relation to GDP and shouldn't be much of a restraint on spending. The government's loss in taxes is the consumer's gain, and the recent dip in the dollar is a plus for corporations based in this country since their earnings from abroad will be translated into more dollars and their competitive position in global markets will improve.

Aside from a rash of surprisingly positive second-quarter earnings pre-announcements, however, it's hard to imagine what might end the stock buyers' strike and scare the bears. Traders placing negative bets on the market have become quite bold. If they can be frightened into reversing their positions, stocks would get a strong jump-start that would attract follow-up demand.

Perhaps stocks have to fall sharply in panicky trading before the air can be cleared and the market can rise in a sustainable way. Prices have been eroding gradually on light volume recently, but climactic conditions can develop quickly. Disillusionment that would accompany a revisiting or undercutting of the September 21 lows might trigger a climax. The S&P 500 is just 11% above its low of last fall. Nasdaq is 14% above its low.

We continue to believe that high labor productivity and a cyclical upswing in corporate profits will boost stocks eventually. For now, though, keep reserves intact. Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook

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