Stocks: New Season, Same Worries

Your summer vacation is over. Here's what to expect for the market in the all-important fall months

This week it will feel different on Wall Street, and it's not just the change of season.

Stocks have traded wildly all summer, pushed and pulled by the fluctuations in the oil market and news from the financial sector. As usual, with many investors and traders on vacation, trading volume has been light. Major indexes are trading more or less where they started the summer in late June.

After Labor Day, however, investors get serious and the summer market doldrums officially come to an end. Traders jump back into the market, and portfolio managers make their bets for the rest of the year. "Investor and trader interest is heightened," says Brian Gendreau, investment strategist at ING Investment Management. On Wall Street, "the pulse picks up and people start reexamining their investment theses."

BusinessWeek asked professional investors which trends could affect the stock market this fall. Here are five factors equity investors should watch in the coming weeks.

1. Oil Prices

As the price of oil hit record levels early in the summer, stocks took it on the chin. High energy costs hurt consumer spending and narrowed corporate profit margins. Since July, oil prices have backed off, and stocks have done a bit better. Oil is now trading almost 22% off its all-time high of $147.27 on July 11.

"The trend [for crude oil] seems to be down at this point," says John Wilson, chief technical strategist at Morgan Keegan. The threat of hurricanes and tropical storms may push oil prices higher, but Wilson believes any rally will be temporary.

Hurricane season, however, officially lasts until the end of November. Stock investors are well aware that a major storm could disrupt oil supplies and once again send oil prices, and prices at the gas pump, soaring. "We're holding our breath," says Richard Sparks of Schaeffer's Investment Research.

2. Credit Markets

Both January and September are crucial times of the year for debt markets, says Brian Reynolds, chief market strategist at WJB Capital Group. Coming after vacations in December and August, respectively, both months are times when a large number of new corporate bonds are issued.

Disrupted by the financial crisis, corporate issuances in January of this year were a "disaster," Reynolds says, noting that it was a preview to several difficult months in the stock market at the beginning of 2008.

Eight months later, will investors in the credit markets be willing to buy new bonds? "We could have a bounce in stocks [this fall], but unless people are buying corporate bonds any bounce will be just that—a bounce—that will be temporary, Reynolds says.

Credit market participants have been even more pessimistic than equity investors this summer. Now that summer is over, investors may decide bonds are at bargain levels, or they may decide the environment is still too risky to be big buyers of bonds.

3. Financial Sector and Housing

Troubled mortgage financiers Fannie Mae (FNM) and Freddie Mac (FRE) grabbed headlines all summer, and investors continue to worry about the threat of more bank failures. Expect this focus on the financial sector to continue in the fall.

Financial problems clearly are weighing on the stock market. It's hard to see stocks experiencing a "sustained rally" without beaten-down financial stocks participating, ING's Gendreau says. However, he adds, it's hard to see financial stocks rallying without some sign that the housing market is stabilizing. Home prices have a direct impact on the value of mortgage-backed debt that has caused huge losses at financial firms in the past year.

On Aug. 26, the S&P/Case-Shiller 20-city home price index showed prices were down 15.9% from the previous year. However, the pace of declines slowed from the previous month. "We're starting to get a mixed picture, which suggests to me the housing market might be reaching for a bottom," Gendreau says.

Future housing data will confirm or refute whether the housing market's pain is starting to fade.

4. The Economic Outlook

Wall Street pros like to say the stock market looks ahead, trying to anticipate corporate earnings and economic conditions six months or so in the future.

The end of summer gives investors a great excuse to pull out their crystal balls and try to predict what the next year holds in store. In September, "you start getting more and more focused on the next calendar year," says Georges Yared of Yared Investment Research. He believes the stock market could rally in expectation of a hefty rise in corporate earnings next year.

One very important clue for next year's environment will be the August employment report, due Sept. 5. Economists are expecting the unemployment rate, after rising in the past few months, to hold steady at 5.7%.

If the unemployment rate keeps rising quickly, the tough labor market could have a big impact on U.S. consumer spending, says Peter Cardillo, chief market economist at Avalon Partners. If the labor market doesn't get much worse, the market could interpret the report as a sign the economy is ready for a rebound in early 2009. This is the best-case scenario, Cardillo says: "The economy limps its way through until we get a recovery."

5. Volatility

Though volatility in the stock market has been high ever since the credit crisis began in mid-2007, the summer of 2008 has been especially wild. Major indexes have swung up or down on the slightest piece of news, with big rallies following just a day after large declines, and vice versa.

There's no reason to think this volatility will stop just because the summer is over, market observers say. Sparks, of Schaeffer's, sees "a lot of apprehension with respect to what's the next shoe to drop." Among the subjects stressing out the markets on a daily basis are the price of oil, credit conditions, and even the election.

Yared believes hedge funds are adding to the volatility. Many hedge funds haven't had a good year, so "they're going to be chasing performance," jumping on each piece of news to ride stocks on the way up or down, he says.

Some investors are watching the 2008 election closely, betting the outcome will have a big impact on sectors like health care, energy, and defense. Other investors, including James King, president and chief investment officer at National Penn Investors Trust Co., argue the election will have little long-term impact. But King admits the election has an effect on market sentiment. It "contributes to the volatility we're seeing in the market," he says.

For investors, the challenge is to look past the stock market's volatile moves from day to day, and even month to month, and decide where stocks are headed much further down the road.

Before it's here, it's on the Bloomberg Terminal.