Published May 11, 2009

WALL STREET INSIGHT
Next big issue for investors: has economy hit bottom?

Many of the bullish strategists are far less certain of the market's prospects

By ANDREW MARKS
NEW YORK CORRESPONDENT
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MANY Wall Street analysts and equity investors hope that last week's release of the results of the US government's stress test of 19 major banks is the final punctuation mark ending the fears of a collapse of the US banking and financial system, which has helped sink the economy into a deep recession and haunted the stock market since last September.

But with questions over the survival of the once mighty financial engines that drove off the stock market boom on Wall Street and throughout the world put to rest at least for the moment, it's time for investors to place their focus squarely forward onto the next most pressing issue: whether the economy has finally struck bottom.

'This rally is all momentum driven and if investors keep getting evidence like the latest jobs numbers supporting hopes that the worst at least is over for the American economy, then it's up, up and away for now,' said Gary Smith, an investment adviser at Exemplar Partners, who has a bearish long-term view on the stock market.

But after such a mighty surge, which has seen the major market indexes rise by as much as 30 per cent since March 9, many of even the stock market's most bullish strategists are far less certain of the market's prospects over the next few weeks.

'Clearly, the market's overdone here, stocks have simply risen in too straight a line for too long and we're overextended in the short term,' said Marc Pado, chief investment strategist at Cantor Fitzgerald, whose strongly bullish call in early March has been vindicated.



Mr Pado, however, is not concerned that stocks could give back most of the gains of the last eight weeks and retest the March lows, as many analysts still worry could happen.

'For a scenario like that to occur, we'd have to see the economy take a real turn for the worse, a next leg down towards collapse rather than the growing signs of decelerating contraction, improving trends, and general stabilisation that the economic data has been providing during the last six weeks,' he said.

Instead, Mr Pado is forecasting a small dip and mostly sideways trading for the next month. 'And then as we get into June, if the May numbers show that we're right about the economy having struck bottom, then we're going to see another big upwards surge in the market,' he said, noting that money market funds, which have doubled in value since September, remain at historically high levels.

The value of money market accounts remains greater than all the equity markets combined. That has only happened twice in history: in 1929-1932 and in the early 1970s.

'Two-thirds of that in institutional cash, which has stayed on the sidelines during this 35 per cent rally, are sceptical it could last. But if we get confirmation that the worst is over and the economy is poised for a late-year turnaround, even if it's only a modest one, I think we'll see a huge rush by institutional investors to get back into the stock market,' forecast Mr Pado.

Last Friday, better-than-expected April employment data, a crucial though lagging economic indicator, gave investors looking for good reason to continue in rally mode with the stress tests finally in the rear-view mirror. Optimism on the economy sent stocks galloping, with the Dow rising 164.80 points, or 1.96 per cent, to 8,574.65, the S&P 500 gaining 21.84 points, or 2.41 per cent, to a close of 929.23, and the Nasdaq Composite advancing 22.76 points, or 1.33 per cent, to 1,739.

For the week, the Dow Jones Industrial Average rose 4.41 per cent, leaving it 2.3 per cent down for the year. The S&P 500 climbed 5.89 per cent, and the Nasdaq added 1.15 per cent.

With the bank stress tests done and earnings-reporting season past its peak, this week will be relatively short on market-moving catalysts, though investors will be on the lookout for further proof that the economy has started to bottom.

Today, Federal Reserve chairman Ben Bernanke will be speaking at the Atlanta Fed on the Supervisory Capital Assessment Program.

Oil prices, which have taken a backseat in the lengthy list of the stock market's concerns the past six months, are starting to draw attention as they approach US$60 per barrel after months in the US$30s and US$40s.

The flow of economic data begins in earnest on Wednesday with the April report on import and export prices, and retail sales data, along with business inventories for March.

On Thursday, the closely watched producer price index for April is scheduled for release, followed on Friday by the April consumer price index, the April report on industrial production and capacity utilisation, the University of Michigan's preliminary read on consumer sentiment for May, and the New York Fed's Empire State manufacturing index for May, which Mr Pado said will be the first May data to indicate whether companies are beginning to gear up to get shelves stocked for the autumn.