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While the stock market is taking a breather today from its marathon rally off the early-October lows, investors still remain pretty upbeat about the future.
There’s still lots to like about this market. The economic recovery keeps puttering along, Europe’s sovereign-debt crisis has simmered down and major stock indexes have returned to levels last seen prior to the financial crisis. The S&P 5o0 is up about 12% this year 28% from early October.
Everything’s all good, right? Not quite, says Nicholas Colas, chief market strategist at ConvergEx Group. He outlines six potential “investment sinkholes” that could derail the current rally.
From Iran to Fed policy and corporate profits, here are several worries Mr. Colas points out:
1. War. The problem here is simple – gasoline prices in the U.S. are at their highest-ever levels for this time of year. The math behind the correlation between economic recession and oil prices is straightforward: $120-140 per barrel (WTI or Brent prices, it seems to matter very little) is the inflection point where the U.S. economy begins to struggle. Anything that puts the supply of oil from the Middle East at risk and pops gasoline prices sharply higher will hurt market confidence that the nascent recovery we've seen in recent weeks is sustainable.
2. Policy mistakes. Thus far the Bernanke Fed is clearly focused on maintaining its uniform message of low rates until 2014. That helps equity prices, both because investors feel confident this narrative isn't about to change and for the valuation reasons mentioned previously. If the market begins to think the Fed is going to change that tune, it will need to feel that corporate earnings are truly on the launch pad to higher levels as an offsetting valuation benefit to the risk of monetary policy uncertainty.
3. Europe. Greece's debt woes are on the back burner for a while, but other periphery countries still have problems aplenty. Frankly, the volatility of the last year has forced so many investors to think through the issues around European sovereign debt that I wonder what could be left in this particular closet. And new European Central Bank Mario Draghi seems to have convinced markets that he will do whatever it takes to keep the liquidity spigot running. As with the prior point, however, this level of central planning is fraught with unintended consequences and moral hazards galore. So some form of follow-on crisis in Europe in 2012 is a possible market risk. Whether it speaks Portuguese, Spanish, or even Italian is harder to know.
4. U.S. Labor Market/Consumer. After the 2007-8 freefall and 2010 glacially slow recovery, the domestic labor market is hitting some kind of stride. Granted, it is more like second gear rather than fourth or fifth, but the rate of change is positive. What we don't know is how much of this is organic improvement versus more transitory from factors like an early Spring. Weather and seasonality plays a greater role in the labor market than most investors realize – just look at the adjustors for the weekly Initial Claims series and you'll see that hiring patterns move around by almost 100% from low to high over a year. Any pullback in the monthly labor market data from 200-250,000 jobs added per month would put a real dent in market psychology.
5. China. European debt problems have taken up a lot of market attention in the last six months. But in second place for furrowed-brow inducing international news is the slowing pace of growth in China, now the world's third largest economy. The lack of transparency into this market makes calling a Chinese “Hard landing” versus “soft” essentially a guessing game. One decent “Tell”: the price of oil and copper don't yet show much weakness. But any break in those unofficial indicators of economic growth in the Middle Kingdom will set off another round of worries.
6. Corporate Earnings. Saving the best – or at least the most immediate – for last, there is less than a month before U.S. listed companies start reporting their calendar first quarter results. Analysts are prepared for some downbeat reports, with revenue growth for large multinationals to be only 3-5% on average. It is hard to get a lot of earnings leverage with that kind of top line expansion, and any cost creep will be easy to spot in the form of earnings disappointments.
The S&P 500 pared earlier losses and was recently down 3 points, or 0.2%, at 1407. Reason No. 5 has had a big impact on today’s action as concerns about China’s economics growth tamed some recent investor enthusiasm.
The big caveat is these issues have existed for quite a while and stocks have still been able to rally. The common cliche is stocks have been climbing the “wall of worry.”
Whether stocks have the stamina to keep climbing remains the multi-million dollar question.
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I see the short sellers are making a ton on LGF after hours!
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