After an unusually powerful stock market rally amid a still-fragile economy, analysts are on the lookout for a downturn.
Many thought it had arrived Monday when the Dow Jones industrial average dropped more than 186 points.
“Everyone was jumping up and down saying, ‘Today’s the correction,'” said Oppenheimer & Co. strategist Brian Belski.
But then Tuesday arrived, and investors sent stocks higher again.
“We will see a pullback at some point,” Belski said. But he doesn’t think it’s likely in the next few weeks because virtually every professional is watching for it.
Changes in the market have a way of sneaking up on investors. That was clear late last year, as all eyes were hunting for a market bottom that didn’t arrive. Instead, the market plunged to a multiyear low in March, and then the stock market shot up so quickly from there that many fund managers didn’t have time to pick off bargains.
Now, investors have to be willing to shop for stocks that are no longer cheap. And that adds to the unease and puts professionals on watch for a downturn. But in a market that won’t stop climbing, the pros are reluctant to lighten up on their holdings.
After missing much of the rally as they worried about the economy earlier this year, “they are under so much pressure to perform,” Belski said.
That means rallies often build on themselves as investors rush in, but such dramatic run-ups can be fragile. When bad news hits, traders may get nervous and sell, and the momentum can drive a sharp downturn.
The arguments for a correction of perhaps 15 percent to 20 percent keep building as the rally carries the market about 50 percent above its lows at a time of year that’s notoriously tough on stocks.
“Markets tend to peak in the months of August or September, so we are watching for signs that an intermediate top has formed that would result in an equity market correction,” Merrill Lynch technical analyst Mary Ann Bartels said in a report this week. “As we move into the fall months of September and October, the risk is for a 15 percent to 20 percent pullback.”
Merrill Lynch small-cap strategist Steven DeSanctis said he is “especially worried” about the smallest stocks in the market because they have “far exceeded their typical bear-market bounces.”
Since early March, the Standard & Poor’s 600 small-cap index has climbed 62 percent, while the S&P 500 index of large-company stocks is up about 46 percent. The S&P MidCap 400 index is up 57 percent.
Although some upturn in the markets is warranted now that a financial collapse has not occurred, some strategists argue that the recent trajectory is overdone.
David Rosenberg, economist for Gluskin Sheff & Associates, said the price of the stock market “is the richest in five years.” Stocks are priced for 4 percent real growth in gross domestic product and 40 percent corporate earnings growth, he said.
Typically, when expectations are too great, stocks fall as investors digest reality.
Rosenberg wonders what could propel the type of growth priced into stocks. Although most companies reporting earnings for the second quarter exceeded analysts’ expectations, revenue growth has been missing.
Companies have been slashing costs, including payrolls, dramatically to preserve margins. But with unemployment at 9.4 percent, Americans have not been willing to do much shopping, and the consumer drives 70 percent of the economy.
On Tuesday, Home Depot Inc., Saks Inc. and Target Corp. all reported results that exceeded analyst projections, but sales declined. Consumers continue to labor under massive debt levels and joblessness, and cost-cutting by companies to secure profits leaves behind uncertainty about jobs and frugal behavior.
Investors sold stocks Friday and Monday as they eyed consumer behaviors and digested news that suggested China might not be on the strong growth spurt some imagined. Although investors see reason for a short-term rise in the economy as companies build up depleted inventories and auto sales rise, the longer term appears less promising, many experts say.
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gmarksjarvis@tribune.com
