Pros Cast a Wary Eye on Rising Stocks, Rates

The stock market's recent strength has been matched by a concomitant rise in interest rates. While equity investors appear nonplussed about the spike in Treasury yields to near six-month highs, a steady rise in rates could ultimately undo the recovery of corporate profits and the housing sector—two factors equity investors have been counting on as they bid stock prices higher.

What do Wall Street pros have to say about the current action in stocks and yields—and other important topics? BusinessWeek compiled comments from economists and strategists on June 2:

Alfred E. Goldman, Wells Fargo (WFC)

Despite our bullish stance on the stock market and optimism about the economy, we advise investors to be a bit cautious. Both the [Dow Jones industrial average] and the S&P 500 are back up, close to recent highs and extended. This does not mean that the stock market cannot go higher from here. We believe it does mean that the risk/reward ratio for new purchases has become dicey. We continue to favor quality growth companies in the technology, oil-service, health care, biotech, and discount-store sectors. However, we would not chase stocks up here and would hold back some buying power.…Having some cash available to buy stocks on sale makes investment sense at this time.

On Friday, we get a May nonfarm payrolls report that is expected to show 520,000 jobs lost vs. 539,000 in April, and the unemployment rate is expected to rise to 9.2% from 8.9% in April. Unemployment is a lagging economic indicator and will likely stay negative for a year or longer after the end of this recession. So, once again, the mettle of the market will be tested as the economic news shifts back to "less bad."

Phil Roth, Miller Tabak

We note only slight inflows into equity mutual funds recently after massive outflows for months and a shift to modest selling by insiders after solid buying in the fourth quarter of 2008 and the first quarter of 2009. Meanwhile, equity financing remains substantial and supply from secondary offerings has soared to record levels, leaving fickle hedge fund trading activity the primary sizable demand factor. Commodity prices continue to strengthen and the dollar has weakened further, combining to put pressure on long-term interest rates and to inhibit narrowing of the negative corporate bond-Treasury bond yield spreads.

The short-term outlook: Another fully confirmed new rally high adds life to the interim recovery advance.

Action Economics

U.S. mortgage rates are backing higher with underlying Treasury yields even as the Fed attempts to keep optimism from breaking out prematurely and undermining the recovery. (RATE) shows the 30-year fixed rate [on mortgages] surging from April lows near 4.70% to an average of 5.33% currently. A relatively live quote for the same rate on shows a bounce to 5.38% for a 30-year compared to 4.90% in mid-May, 4.89% on a 15-year and 4.48% for a 5/1 ARM.

Though the chairman of the National Association of Home Builders said recent housing indicators…suggest the housing market is "at or near a bottom," a steady grind higher in rates will continue to dent refinancing activity and could put some ARM-based mortgage households back in jeopardy.…That said, peak summer selling season, lower home prices and inventories, all set against pent-up demand and fixed rates still below the 5.75% five-year average, may prove supportive to the sector.

Beth Ann Bovino, Standard & Poor's (MHP)

The National Association of Realtors stated that pending home sales (based on contracts signed in April) jumped 6.7%, its third consecutive increase. The index is now up 3.2% from a year earlier. Jumps were concentrated in the Midwest and Northeast. The increase reflects in part the new tax credit, but also high affordability. The Realtors' affordability index jumped to a 174.8 in April, from 171.9 in March, just below the record 176.9 set in January. Lower home prices and lower mortgage rates have improved affordability. The new ability to use the $8,000 tax credit as a down payment on a home alleviated the remaining obstacle—lack of funds for a down payment.

Pending home sales are a leading indicator for actual sales, which are counted when the final deed is transferred, usually one to two months later.

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