Published May 18, 2009

WALL STREET INSIGHT
Pullback seen extending as caution reigns

Some expect mild retreat, others think market may retest March lows

By ANDREW MARKS
NEW YORK CORRESPONDENT
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US STOCKS have soared over the past two months as investors flocked back to the market, relieved that the financial system had narrowly avoided a worst-case scenario and stabilising economic indicators showed that the recession was not worsening.

Lengthening shadow: Should the recent trend of positive data show further signs of reversing this week, it could erase the wave of positive sentiment, and likely take the equity markets down with it

Eventually though, 'less bad' had to equal not good enough as a reason to maintain a rally that has propelled stocks up by 30 per cent since the US government's release of its bank stress-test results.

Last week, that eventuality finally came, as investors used a less-than-stellar read on the recovery, in the form of the April retail sales report, as an excuse to pull the cord on the stock rush.

The drop back to earth is likely to continue this week with profit taking and caution gaining ground against optimistic views that the economy is closing in on a recovery.

Most Wall Street traders and money managers foresee only a mild pullback, in the 5 to 10 per cent range, over the next few weeks, a gentle landing that most investors will be only too glad to accept after enjoying a 30 per cent-plus rocket ride up in little more than eight weeks. But some Wall Street analysts think the pullback might very well end in a bearish thud that retests the March lows.

Last week's 0.4 per cent drop in retail sales surprised most economists, who had been expecting flat to slightly higher sales in April for retailers.

'It was inevitable that this rally couldn't go on. A lot of the move up was based on momentum alone and then there was the euphoric reaction in anticipation of the stress-test results. Now the stock market has to come to grips with the logic behind the rally off the March lows and decide whether there was enough reason to have come back so fast and so far,' said Gary Smith, who is bearish on stocks.

Indeed, the optimism over an economic recovery, with Wall Street analysts and stock market investors fastening their attention on so-called 'green shoots' of economic activity that has hinted that the worst is over for a recession that has plagued the world's largest economy with one of its most severe and prolonged contractions since the depression-era days of the stock market crash of 1929-1932, remains based in hope and anticipation as much as reality, economists agree.

'We're still a long way from being able to declare the worst over for the economy without a doubt,' said Joel Naroff, president of Naroff Economic Advisors. 'This could turn out to be a more difficult summer than many people are thinking.'

Last week's 0.4 per cent drop in retail sales surprised most economists, who had been expecting flat to slightly higher sales in April for retailers, and puts a dent in hopes that economic data was trending solidly towards showing a stabilising economy.

Should the trend show further signs of reversing this week, it could erase the recent wave of positive sentiment that had many thinking that the economy would steadily improve, and likely take the equity markets down with it.

Still, other analysts argued that the optimism on the economy is not a fantasy. 'The numbers we've been seeing the last several weeks are evidence of a bottoming trend, and a bottom leads to a rise. What you're seeing now is a very sensible decision on the part of investors, who are going to shift into more of a wait-and-see mode on the economy and the stock market,' said Nick Colas, chief market strategist at BNY Convergex Group.

Last Friday, all three major US stock indices retreated after a modest gain on Thursday ended a three-day losing streak, the market's longest since March. The Dow Jones Industrials fell 62.68 points, or 0.75 per cent, to close at 8,269. The S&P 500 lost 10.19 points, or 1.14 per cent, to 883, while the Nasdaq Composite dropped 9.07 points, or 0.54 per cent, to 1,680.

For the week, blue chips fell 3.6 per cent, the S&P 500 index lost 5 per cent, and the Nasdaq fell back 3.4 per cent , it's first weekly loss in 10 weeks.

A light economic calendar this week will provide little incentive for investors looking for reasons to buy, or to make up their minds over the timing of an economic recovery

Today, the National Association of Home Builders housing-market survey for May is scheduled for release, followed by housing starts numbers tomorrow.

On Wednesday, minutes from the last Federal Reserve interest rate policymaking committee meeting in April, and the Fed's economic forecast are released. Treasury Secretary Tim Geithner testifies before Congress on the Troubled Asset Relief Program on the same day.

The Philadelphia Fed survey is on Thursday, as are April leading indicators. Weekly jobless claims are also reported on Thursday.

The lack of headline economic data over the next five trading days will push first quarter earnings reports back into the spotlight.

The week in earnings will feature retailers, whose reports will be even more in the spotlight thanks to last week's disappointing retail sales data.

Saks reports its results tomorrow, with AnnTaylor and Target scheduled to announce their numbers on Wednesday. Thursday brings Gap, Foot Locker and Aeropostale.