Clouds Gather Over Stocks

By BusinessWeek staff

Without a fresh batch of "green shoots" to chew on, U.S. stocks got a case of indigestion on June 15. With the equity rally in its third month, investors decided to take some profits off the table after some damp economic data —including a worse-than-expected reading on the New York Fed's Empire State index, a gauge of manufacturing conditions. Major indexes sank more than 2% on the session.

What did Wall Street economists and strategists have to say about the data—and the state of the stock market—on June 15? BusinessWeek staff compiled this selection of comments:Michael Englund, Action Economics

Today's U.S. Empire State report for June was a tad weaker than we had assumed, but this volatile index is still roughly tracking the broader pattern of improvement from the late first-quarter trough…[t]he headline index drop to -9.41 in June from -4.55 only slightly reverses the prior two-month rise from the all-time low of -38.23 in March.

The index of the number of employees rose slightly, to -21.8 from -23.9 in May, and an all-time low of -39.1 in February, while the workweek measure rose to -21.8 from -22.7 in May and a February all-time low of -31.0. Both small gains are consistent with our June nonfarm payroll estimate of a 340,000 drop that is just a tad smaller than the 345,000 May decline, but much larger 504,000-741,000 monthly drops in the six months before that.

The capital-expenditures plans index rose to 11.49 to leave a fourth consecutive monthly gain from the -19.1 cyclical trough in March, with a reading that is now similar to the 10.3-11.4 readings seen at the start of the last expansion…. W]eakness in the economy has now shifted to business fixed and inventory investment from the consumer, so this gain is an encouraging sign for hopes of positive GDP growth in the second half of 2009.Tobias Levkovich, Citigroup

The sizable backup in Treasury-bond yields has cast a new shadow over stocks, especially following a near 40% surge in the S&P 500 off of its March lows. Even short-term notes have moved considerably, allegedly indicating a likely shift in Fed policy, which seems fairly premature given forecasts for a weaker rebound in this economic recovery than seen in the past.

The Fed's Flow of Funds report illustrates that international investors remained buyers of U.S. stocks and bonds in the first quarter of 2009 despite the meltdown worries that existed at the time. It seems challenging to buy into the view that the Chinese and Japanese suddenly will stop buying U.S. government bonds when there is a "vendor financing" element in place to support their export-driven economies. Oil prices have more than doubled off of their lows, generating additional unease about consumer activity especially as unemployment grows and wages recede. Yet oil prices are still down 47% year-over-year, and equity price levels seem to have much more impact on consumer activity, especially when overall production trends look poised to pick up and should cause job-loss diminishment in the second half of the year. While household net worth dropped an additional 2.6% in the first quarter and is now down 21.6% from the peak, stocks have accounted for the bulk of that decline (not housing, as is often cited) and thus the data do not encompass the near 20% rally since the end of March.

In this context the price appreciation in various indices would argue for meaningfully better wealth figures. Indeed, stock price direction may be more critical for economic strength than is generally recognized and actually has more impact than home prices.Jeffrey D. Saut, Raymond James

To us, the current markets feel more like 2003, when the S&P 500 rallied from its March lows of roughly 800 into its June highs of around 1000. From there stocks chopped/flopped around, without giving back much ground, until early September, when they again rallied to break out above those June highs on another upside leg that tacked on an additional 150 points (to 1150). While history doesn't repeat itself, it often rhymes! If so, a Dow Theory "buy signal" will be rendered if the Dow Jones industrial average and the DJ Transportation Average can better their respective January 6, 2009, closing highs of 9015.10 and 3717.26. If that happens, it would be termed a new bull market according to our interpretation of Dow Theory. Whether that occurs or not, we think the emerging/frontier markets have already embarked on new bull markets.

As for the recent mantra that "Buy and hold investing is dead," while we questioned this "ride it out&quo mantra in late 2007, we think the current consensus "dissing it" has it wrong. Emphatically, one of the secrets to Warren Buffett's long-term investment results is embedded in the tax code (i.e. long-term capital gains)…. We continue to invest accordingly.

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