Where Do Stocks Go from Here?
Stocks are bouncing higher today after some hefty declines this week. The S&P 500 flirted with some support areas around 1,300. There was a virtual consensus that stocks were overbought and needed a pullback, and we got one.
The question is: was that enough to relieve some of the pressure and give stocks room to rally higher?
I suspect we will see a period of consolidation before stocks make a decisive move. Investors appear to be more focused on the crosscurrents of economic data and trends.
On the positive side, we have decent consumer spending, still-improving corporate earnings and stocks are trading at relatively fair valuations.
On the negative side, GDP isn't growing as fast as we might hope, spending at the state level is struggling, and we have instability in the Middle East.
*****The wild cards are oil and the Fed. We just got a stark reminder of how quickly oil prices can move. Supply and demand for oil is tight enough that any hint of disruption can lead to price spikes. And clearly, higher prices at the pump puts a crimp on household budgets.
We are now about 3 months from the end of QE2. And while there's plenty of speculation as to just how much the Fed's bond-buying policy has affected real economic growth, there should be no doubt that the Fed's actions have helped drive a psychological change in the stock market.
Yes, I agree, $600 billion is a pretty expensive therapy session. And there's no telling how the Fed will bring its balance sheet back in line once QE2 is over.
It's widely assumed that the Fed will have to dump its Treasury Bonds on the market at some point. But does it matter if it doesn't? In accounting terms, bonds are equivalent to cash. And with virtually no oversight, there won't be any pressure on the Fed to unwind its bond position.
The more pressing question is how will the stock market react to the end of QE2? I'm not sure there's any way to answer this question, and so it will be an uncertainty that will be hanging over the market.
*****In my opinion, oil and energy prices remain the primary concern for the U.S. economy. In the short term, rising oil prices threaten the economic recovery.
$100 a barrel oil costs about 1 percentage point off of GDP. $120 a barrel oil is worth around 2 percentage points. When giving GDP estimates for 2011, most analysts and economists have factored in an average price between $80-$95 a barrel. If oil trades at the upper end of that range, or even higher, we will see GDP estimates revised lower. And that's not usually good for stocks.
High energy costs are also at the root of long-term structural imbalances in our economy. The U.S. economy was built on cheap energy prices. In my opinion, energy costs are the biggest factor weighing on wages and unemployment. We're simply not as wealthy in this era of high oil prices.
*****Now, we got a fairly weak revised GDP number for the Fourth Quarter. 4Q GDP growth was 2.8%, much lower than the 3.2% initial read.
Now clearly, that's not a good number for unemployment. It's enough growth to keep unemployment numbers stable, but isn't going to add jobs. At the same time, weaker GDP growth keeps a lid on oil demand in the U.S, and hopefully, on prices.
For this particular market, GDP growth in the 2.5%-3% range is ideal. It keeps the Fed active, it keeps unemployment from getting worse and it moderates energy prices.
At this point, corporations have adjusted to current unemployment and spending levels. There's probably not a lot of upside for earnings. And so stocks are likely to be somewhat stagnant.
*****I realize that's a rather longwinded explanation for why I think stocks will be range-bound for the foreseeable future. But it should keep us focused on what's important to the stock market right now.
*****Next Tuesday is the first day of March. And the first day of the month has consistently been a strong up day. So I expect a bullish bias for the next couple days.
