Washington — U.S. stock investors applauded Federal Reserve Chairman Ben Bernanke’s reassuring speech on Friday, but many potential buyers are still sitting on their hands.
Bernanke’s message was that the central bank has tools at its disposal to spur economic growth, and at their meeting next month policymakers would assess the toll that stock market weakness, debt-ceiling negotiations and the European debt crisis has taken on the U.S. economy.
Stocks traded higher Friday after Bernanke’s speech in Jackson Hole, Wyo., with both the Dow Jones Industrial Average and the Standard & Poor’s 500-stock index posting solid gains that added to a string of upbeat sessions this past week.
Is the market’s recent rally sustainable? That depends on whether the upward move is simply profit-taking, or if it’s an early sign that investors are gaining enough confidence that recession can be avoided and corporate earnings will grow to shift money out of gold, Treasury bonds and other safe havens and take more risk with stocks.
To be sure, the risk of recession is above normal. The U.S. economy is weakening at an accelerated pace, based on the latest data from the Economic Cycle Research Institute. The ECRI’s Weekly Leading Index growth indicator, reported Friday, showed U.S. economic growth at negative 2.1% for the week ended Aug. 19. A week earlier, the WLI went negative for the first time since mid-December 2010. (The ECRI has cautioned that moves in the growth indicator must be prolonged and persistent before the readings can be called a trend.)
But the stock market is a forward-looking mechanism, and part of the reason for stocks’ swoon this summer was due to investors repricing equities to better reflect corporate earnings growth expectations. That reassessment may not be finished. September has been the worst-performing month of the year for the Dow and the S&P 500 since 1950, according to the Stock Trader’s Almanac. Nasdaq stocks typically haven’t fared well in September either.
So it may be a while before buyers spy a bit of sunlight through the clouds. Specifically, what do investment professionals — financial advisers and mutual fund managers with a mandate to shift among stocks, bonds and cash — need to see in the economic and political climate in order to put more money into stocks? Here are five potential catalysts:
1. The U.S. deals with its debt crisis
The debt crisis that caused rating agency Standard & Poor’s to strip the U.S. of its triple-A Treasury rating is the first fundamental burden on the equity market. It would provide a relief to the market if the newly created congressional “super committee” tasked with cutting the U.S. budget deficit could reach a bipartisan deal providing a long-term map for how the U.S. will resolve its budgetary problems.
“If the committee comes up with something that shows the Democrats and the Republicans are able to get together and compromise, that will be treated favorably by the market,” said Lewis Altfest, CEO and chief investment officer at Altfest Personal Wealth Management in New York.
A meaningful compromise would take into account the cutback in entitlements and the restructuring of taxes that would resolve the current financial budgetary difficulties in a believable way, Altfest said, though he added that such a deal appears unlikely until after the 2012 presidential election.
2. Europe sees resolution of its own debt woes
Concerns over the eurozone’s ongoing debt crisis are also weighing on U.S. stocks. A resolution of Europe’s financial instability would be a green light for stock investors.
The sovereign debt crisis in European countries like Portugal, Ireland, Italy, Greece and Spain has negatively impacted banking and sent shock waves across the region.
“One of the key driving factors behind this gigantic instability in the financial market to the equity market is the fact that you’re really looking at a major banking crisis in Europe,” said Frank Barbera, executive vice president at Sierra Investment Management in Santa Monica, Calif. and co-portfolio manager of Sierra Core Retirement Fund.
“On the fundamental level, we’d have to see some kind of greater leadership on the political side, in terms of allaying some of the worst fears throughout Europe with regard to the very fragile situation that exists with Europe’s heavily indebted banks,” Barbera added.
If European countries could reach an agreement that they are going to have control over the spending habits of individual countries, as judged by one central authority, that would be a positive sign for the equity market, added Altfest, the New York investment adviser.
3. Retail sales strength improves
Firm retail sales in August would encourage the market at least on a short-term basis, Altfest noted.
“If August retail sales turn out to be strong, it would mean that people are looking past the credit downgrade and the fears of recession and they’re going about their businesses,” Altfest said. “That would be very positive and would result in a strengthening of stock prices.”
Retail sales climbed 0.5 percent in July, the most in four months. The August number will be released by the Department of Commerce on Sept. 14.
Barbera pointed out that retail sales excluding gasoline provides a much more realistic view of the health of consumers’ discretionary spending.
“If we saw spending and sales still holding up even in the wake of a market decline, that could be an encouraging sign,” Barbera said.
Meanwhile, a gloomy consumer confidence report next week could weigh on investor sentiment, Barbera cautioned.
The private research firm Conference Board’s consumer sentiment index for August will be released on Aug. 30. The Conference Board’s consumer-confidence index improved to 59.5 in July from 57.6 in June.
4. Gold, Swiss franc weaken
A decline in the value of gold and the Swiss franc would be another upbeat sign for the stock market.
As a measure of fear, gold has been soaring in price, driven up by investor concerns over the U.S. and Europe’s economies, as well as a conviction that gold is an alternative currency to the U.S. dollar, the euro and other paper money.
If the gold prices start to move south, that would suggest greater comfort with the economic environment and a willingness to take higher risk, which would be positive for stocks, Altfest said.
The same would be true of weakness in the Swiss franc, another safe haven. “If that were to start to weaken, I would say ‘OK, the market is taking on a better tone,’” Barbera noted.
5. Bank stocks strengthen
Warren Buffett’s $5 billion lifeline to troubled Bank of America Corp. earlier this week seems more of a bet on the company — on highly favorable terms — than on the banking sector as a whole.
The financial services sector is the U.S. market’s worst performer so far this year, and Buffett’s support for BofA and Wells Fargo & Co. doesn’t change the fact that a large number of investors do not view the nation’s biggest lenders as undervalued bargains.
“People are very nervous about the banks, and for the banks to do well would suggest that people are lessening their concerns about the economy,” Altfest said.
It will likely take a long time for the banking sector in both the U.S. and Europe to unwind its problems.
But financial services stocks nowadays are an area for investors who go against the herd, and who show the ability, as Buffett has said, to “be fearful when others are greedy and be greedy when others are fearful,” are finding selective bargains in the financial sector.
A contrarian outlook, in fact, is key to taking advantage of an unsettled market, said Alan Lancz, a portfolio manager and investment strategist in Toledo, Ohio.
True to form, Lancz said he is taking small bites of certain banking and brokerage stocks on weakness, singling out J.P. Morgan Chase & Co., U.S. Bancorp and Goldman Sachs Group Inc. as companies fitting the bill.
“I’m not saying it’s a bottom,” Lancz noted, “but the valuations are looking appealing to us where they didn’t before.”