Stock Rally at Risk as Fed Ponders Exit Strategy
STOCK MARKET, INVESTMENT STRATEGY, S&P 500, NASDAQ, DOW, OIL, FEDERAL RESERVE
Reuters
| 03 Apr 2011 | 11:57 AM ET
The Standard & Poor's 500 index is poised to hit its highest mark in nearly three years this week after more signs of life from the jobs market, but think twice before betting the house.
Many investors are coming to the view that the U.S. employment situation has turned a corner, but the risks that sent stocks cascading between mid-February and mid-March are as real as ever.
In addition, the surprisingly robust recovery shown in recent economic data has some investors nervous that the Federal Reserve may end its easy money policies before schedule and increase interest rates in the second half of the year.
That could be spell trouble for risk assets such as stocks and commodities that have benefited from the added liquidity provided by the Fed's $600 billion Treasury bond buying. The program, known as quantitative easing, or QE2, is slated to end in June.
"The Fed is now going to much more seriously consider early withdrawal of QE2 because these numbers are getting stronger," said Kenneth Polcari, managing director at Icap Corporates, a floor broker at the NYSE.
One Fed official poured cold water on that idea on Friday, saying he saw no reason to reverse course even as the economy adds jobs. The comments helped cement optimism over the jobs data.
Recovering Losses
Polcari said the data would provide the fuel to send the S&P 500 to 1,350 this week.
The Dow Jones industrial average hit 12,419.71—its highest intraday level going back to June 2008—before closing up 56.99 points, or 0.46 percent, at 12,376.72 on Friday. The S&P rose 6.58 points, or 0.50 percent, to 1,332.41.
The Nasdaq Composite gained 8.53 points, or 0.31 percent, to 2,789.60.
For the week, the Dow gained 1.3 percent, the S&P added 1.4 percent and the Nasdaq rose 1.7 percent.
The Dow has recovered most of its losses since February as U.S. employment recorded a second straight month of solid gains in March and the jobless rate fell to a two-year low.
The jobs report chimed with the view that the U.S. recovery is becoming self-sustaining.
"The numbers are looking pretty powerful," said Jim Awad, managing director at Zephyr Management New York. "You have got strong and perhaps accelerating economic growth, you have good profit growth, you have fair valuations, you have momentum, and you have high merger and acquisitions activity."
But uncertainty arising from world trouble spots shows scant sign of abating and is likely to contain stock prices.
U.S. crude hit its highest this year, driven largely by unrest in the Middle East. Ratings agencies warned of trouble ahead for debt-laden Ireland and Japan looked set for a long-haul in containing its nuclear crisis.
'Investors Should Be Cautious'
But for the time being investors seem content to focus on the United States. How long that continues will depend to a large extent on whether the economy lives up to expectations.
"Two months of improvement does not satisfy the definition of a trend," said Chad Morganlander, a portfolio manager at Stifel Nicolaus in Florham Park, N.J. "Investors should be cautious."
Weekly jobless claims data this Thursday will be closely watched and are expected to highlight the improving trend in the labor market, while a report on the non-manufacturing sector on Tuesday is also tipped to point to growth.
William Dudley, president of the New York Federal Reserve Bank, said the economy could add jobs more rapidly in the months ahead. He said he saw no reason to cut short the Fed's quantitative easing program.
Investors will look to other Fed officials to confirm those sentiments this week.
Chairman Ben Bernanke will speak on Monday, Atlanta Fed President Dennis Lockhart has three speaking engagements and Richmond Fed President Jeffrey Lacker will speak on Thursday.
An optimistic but cautious view from the Fed is likely to keep expectations for an interest rate hike under wraps.
Following Dudley's comments on Friday, futures implied a 38 percent chance the U.S. central bank would raise rates from near zero to 0.50 percent after its December policy meeting.
After the release of the payrolls data, but prior to Dudley's comments, futures implied a 64 percent chance of such a move, up from 32 percent.
Even when the S&P 500 does get up to its recovery high of 1,344, it is likely to run into some resistance when traders that bought at the high close out positions at break-even.
Bob Doll, chief equity strategist at BlackRock, recently told Reuters that he expects the S&P 500 to be range-bound between 1,250 and 1,330 until there is more clarity on risk, particularly the price of oil.
However, investors who like market seasonalities, have reason to be bullish. April is the best month for the Dow industrials, which have averaged a 2 percent gain during the month since 1950, according to the Stock Traders Almanac.
