Encouraging Resilience

The market tone has improved, despite weak economic news. This raises hopes that a bottom is taking shape

By Arnie Kaufman

Stocks tend to overshoot fundamentals at peaks and troughs. The emotion-charged plunge to the July 23 low apparently made more than adequate allowance for existing problems and risks, especially in light of the reduced appeal of investments that compete with equities.

The yield of the benchmark 10-year T-note briefly dipped below 4% last week to the lowest level since 1973, before recovering to 4.3%. Money market rates, already meager, should at best stay flat for several months now that the Federal Reserve has turned more cautious on the economy.

We see evidence that institutional investors are adjusting their portfolio allocations by shifting funds from fixed-income instruments to equities. With bargain hunters testing the water and short sellers moving more carefully, overall supply and demand are in better balance.

Because the recession was shallow, the recovery is modest. Still, S&P is looking for an acceleration in GDP growth to 3.2% for the current quarter and 3.6% for the fourth quarter, which would be around the historical pace.

Investor skepticism has diminished somewhat now that many companies have certified their financial statements and the Financial Accounting Standards Board has indicated that it will soon require the quarterly reporting of options expense. A recent pick-up in share buybacks and in mergers and acquisitions is also a promising sign.

The market at this point doesn't have the benefit of a strong sector or two providing sustainable leadership. And chart patterns for many stocks suggest that overhead resistance could become heavy, which could take the wind out of the rally's sails.

Nevertheless, we feel that a policy of selective and unhurried accumulation will prove rewarding over the long pull.

Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook