Disappointing reports on home sales and economic growth weighed on stocks last week, but investors may want to reserve judgment before making any wholesale changes to their portfolios.
Market experts say the latest dismal data signal a brief slowdown, but they remain steadfast in their predictions for a modest, if jerky, recovery.
The Dow Jones Industrial Index dropped about 2.7% and the S&P 500 shed 3.6% last week after brutal housing numbers and a downward revision to the first-quarter gross domestic product. Meanwhile, the Federal Reserve continued its near-zero interest rate policy for another month.
Market strategists and economists cautioned investors that sometimes, this is what a recovery looks like.
Jeffrey Kleintop, chief market strategist for LPL Financial, said soft spots in an economic recovery are common occurrences, and that "the combination of Europe’s debt problems and evidence of slower growth in China are adding to the anxiety over the slowing of the pace of improvement in the U.S. economy."
In a note published June 21, he charted nine previous dips dating back to 1949, and noted that “these soft spots were not signs that the recovery was going to fail. In fact, in every case the recovery was successful and a multiyear period of economic growth followed."
Nonetheless, investors have been moving to curb their risk lately. They pulled out $1.8 billion from equity mutual funds in the week ending June 16, according to Investment Company Institute fund flow data. They put $4.5 billion into bond funds.
The latest housing data offered little comfort. Existing home sales for May dropped 33% from the preceding month following the expiration of the federal home buyer's tax credit, one of the government's most visible forms of support for the recovery. Societe Generale economists Aneta Markowska and Stephen Gallagher said Wednesday that "the payback effects following expiration of tax incentives were much more severe than anticipated," and warned that worse data for the sector would come in the June and July figures.
Noting that “housing starts remain at a depressed level,” the Fed on Wednesday announced it would leave interest rates intact. Channel Capital Research chief investment strategist Doug Roberts approved.
"There was no reason to take chances with any hawkish language given the mixed economic news, uncertainty in Europe, and lack of any inflationary pressure," he wrote, adding that rates probably wouldn't rise until unemployment fell.
While fears of a jobless recovery persist, Doug McKay and Bill Hoover, chief investment officer and president, respectively, of Broadleaf Partners, said Wednesday that investors will have to adjust their expectations.
"In such an environment, nominal gains in the stock market may be lower and dividends and active management may therefore play a more dominant role in generating outperformance," they wrote.PNC chief economist Stuart Hoffman has long contended that this recovery is moving at half-speed, but on Friday he wrote that "we are a half-step closer to 'stall speed,' for the economy in 2010, which we estimate at 2.0% GDP growth" on an annual basis.
Bob Doll, chief equity strategist and vice chairman at BlackRock, wrote Tuesday that the uneven pace of the modest recovery will force some investors to make adjustments for the rest of 2010. The "pullback in growth momentum and decline in risk appetites" are normal and don't herald a double-dip recession, he said. Headlines will get less dire, and the markets will eventually be more synchronized with a slow but steadily improving economy.
"Looking ahead, we expect that equity markets should be able to make additional gains over the course of this year," Doll said. "This outlook is not so much a forecast of significantly improving economic news as it is an expectation that many of the risks facing investors will fade over the coming months."
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