Stocks: Will the Barrage of Bad News Scare Bulls?

Plenty of scary headlines could have spooked the market in the past month but, according to one observer, it's "almost ignoring the news." Spencer Platt/Getty Images

Stocks in the past month bounced off their 2008 lows, but keeping that stock market rally going will be a big challenge for Wall Street's bullish investors.

It's not that the bulls' case is wrong. Many argue that, after aggressive actions by the Federal Reserve and the federal government, the U.S. economy will recover by midyear. And that could happen.

Rather, the bulls' problem is so far their hopes are nowhere to be found in reality. In fact, real measures—from earnings results to economic data—continue to deteriorate at a frightening pace.

Anticipating the December Jobs Report

Plenty of scary headlines could have spooked the market in the past month, from a horrible holiday season for retailers to the collapse of Bernard Madoff's $50 billion hedge fund. However, the market is "almost ignoring the news," says Richard Sparks of Schaeffer's Investment Research.

The broad Standard & Poor's 500-stock index is up more than 20% from its lows of late November. For now, Sparks says, "that uptrend is in place, but I think it's tenuous."

Economic realities could knock stock market optimists off their stride. A key moment will be Jan. 9, when the Labor Dept.'s December employment report is expected to show massive job losses. Economists expect the unemployment rate to jump from 6.7% to 7%, and the U.S. to lose another half a million jobs.

Quincy Krosby, chief investment strategist at the Hartford (HIG), says most professional investors already expect "really ugly" economic data from both the fourth quarter of 2008 and early 2009.

"If [the jobs report is] much uglier than that, we'll see how the market absorbs it," she says. Investors could be spooked if a weak jobs report indicates economic stabilization is even further away.

Action Economics Chief Economist Michael Englund assumes the U.S. unemployment rate could reach 8.6% by the middle of 2009, but then start to recover. Recent estimates by the Congressional Budget Office are especially gloomy: The CBO says the jobless rate could average 8.3% for all of 2009 and average 9% in 2010.

Angst Is Factored In

It's not surprising the market can shrug off gloomy news. After all, the S&P 500 dropped almost 39% in 2008, so investors expect tough times.

"A lot of angst has already been factored into the stock market," says Gary Wolfer, chief economist at Univest Wealth Management (UVSP). But, he adds, "we're still in for a rough patch in the first half of 2009."

The market did flinch after a spate of scary headlines on Jan. 7. The U.S. ADP employment report, though often an unreliable gauge, showed a 693,000 decline in December private payrolls. News broke of accounting irregularities at Indian outsourcing firm Satyam Computer Services (SAY). Intel (INTC) warned sales could plummet 20% in the fourth quarter. Alcoa (AA) announced it's cutting 13,500 jobs, or 13% of its workforce, this year.

The result was the first significant daily decline for stocks in almost three weeks. On Jan. 7, the Dow Jones industrial average dropped 2.7%, while the S&P 500 fell 3% and the tech-heavy Nasdaq composite lost 3.2%.

Reaching Bottom—Again?

The Jan. 7 downdraft is a reminder of how tenuous the market's recent recovery may be. A Standard & Poor's report recently predicted the S&P 500's Nov. 20 close, at 752, is "the likely low of this mega-meltdown." But that doesn't mean stocks couldn't return to those rock-bottom levels. The report added: "We also project that this bottom will likely be retested, thus dragging the S&P 500—and a majority of sectors and subindustries—through another emotional roller-coaster ride before we are more confident that the bottom has been put into place."

Chris Johnson of Johnson Research Group says the market's recent rally is "based on very little reality" and is increasingly fragile. Earnings expectations for 2009 are still too high, he says, and investors are putting too much faith in government efforts to repair the economy.

"How many decades of consumer activity were ballooned by the free credit that was out there?" Johnson asks. "It's going to take more than free credit from the government to fix things."

Action Economics' Englund still expects business spending to collapse—a trend that hasn't yet shown up in data on factory and durable goods orders and nonresidential construction spending.

The key to recovery is a rebound in consumer spending, Englund says. Now, "the consumer is clearly in revolt," he says. "There will be a point where we see stabilization of spending," he adds.

But when? The problem for prognosticators is that both economic and stock market activity don't seem to depend on traditional measures like profits, economic data, or market activity.

A Confidence Game

"So much depends on the return of confidence globally," Krosby says. Stimulus plans from Washington must be well-received, she says, while confidence must return to credit markets.

"It's hard to estimate when the panic ends," Englund says.

Some better-than-expected news on jobs could help stocks continue to rally. But even "bullish" (i.e., not as bad as the market fears) data will still point to serious problems in the economy, and they won't alter the fact that more gloomy news is almost certainly on the way.

For bullish investors, the goal is looking beyond the unprecedented turmoil to eventual recovery. "This is such a leap of faith because we're in such uncharted territory," Wolfer says.

As the bad news continues, it remains to be seen how many investors can keep the faith.

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