Published May 25, 2009

WALL STREET INSIGHT

Cautious investors wait for proof of recovery

Key economic data will determine what the stock market's reality should be

By ANDREW MARKS
NEW YORK CORRESPONDENT

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AFTER surging 35 per cent in just eight weeks, the US stock market rally has shown signs of fraying over the past fortnight, with investors turning rightfully cautious in the absence of confirmation of hopes that the recession has ended and a turnaround has begun.

'We're coming off some very big highs and a surge of optimism that has finally burned off most of its energy. Now, it's time to sober up and get back to reality, and the economic data coming over the next few weeks will go a long way towards determining what the stock market's reality should be,' said Marc Pado, chief investment strategist at Cantor Fitzgerald.

Investors will kick off summer trading this week, asking whether the market has moved too far ahead of economic data.

The market showed some signs of hesitation last week, shrugging off the latest positive news to come out of the still fragile banking sector and paying more attention to lowered economic forecasts from the Federal Reserve.

'It's hard to imagine that we'll see stocks start to move higher from current levels until there's solid proof in the numbers that the worst is over for the economy and a recovery is on the horizon,' said Mr Pado.

With so much important data flowing in, traders are bracing for the possibility of big swings in the major indices. But other Wall Street analysts are less worried, pointing to the receding levels of the Chicago Board of Trades VIX volatility index, which is often referred to as the fear gauge.

The VIX has been steadily coming down from near record high levels and last week, it dropped below 30 for the first time since Lehman Brothers collapsed back in September.

'I would consider a sustained drop below 30 a good sign for the stock market, one that would help make me more comfortable with buying stocks at a time when the market has climbed so fast and is now sporting valuations that are nowhere near as compelling as they were in March,' said Hugh Johnson, chief investment strategist at Johnston Illington Investors.

The VIX's decline indicates that market fears of dramatic downside moves have been largely erased in the last few weeks, and while less fearful investors don't mean a bull market, it does reduce the chances of a dramatic sell-off that would have stocks retesting the white-knuckle lows of March.

Last Friday, the Dow Jones Industrial Average slid 14 points or 0.2 per cent to close at 8,277, after a late round of selling reversed what appeared to be a day of solid gains. The S&P 500 edged lower by 1.3 points, or 0.2 per cent, to 887, while the Nasdaq Composite Index dropped 3.2 points, also a 0.2 per cent decline, to finish the week at 1,692.

Despite Friday's dip, all three major market indices finished in positive territory for the week, led by the Nasdaq, which climbed 0.7 per cent. The S&P 500 rose 0.5 per cent while the Dow squeezed out a narrow 0.1 per cent gain.

The coming short trading week, in which trading on the New York Stock Exchange resumes tomorrow after the Memorial Day holiday, is replete with key economic data that should offer investors their strongest evidence yet in determining whether the economy is moving into position for a recovery by the end of this year.

Although Wall Street economists are expecting all of the reports to offer strong proof that the recession remains in place, many are expecting the data on housing, manufacturing, and consumer behaviour to show that the so-called 'green shoots' of economic recovery are continuing to sprout throughout the US economy.

Tomorrow brings the March reading of the S&P/Case-Schiller home price index, which is expected to show an 18.4 per cent decline after the 18.6 per cent drop in February, followed later in the day by the consumer confidence index.

On Wednesday, investors will get the April report on existing home sales. Economists expect the number to improve to 4.65 million annualised units from 4.57 million in March.

Wall Street traders pointed to Thursday as possibly the most important day of the week, featuring not just key economic data in the form of April durable goods orders and new home sales as well as the weekly report on initial jobless claims and crude inventories, but also one of the last key first-quarter earnings reports with leading computer maker Dell announcing its results.