Friends of the U.S. Chamber of Commerce

August 20, 2012
Wall Street Journal
JONATHAN CHENG

U.S. stocks are close to their highest level in almost five years—a feat that should spark cheers across trading floors. Instead, market participants have reacted with skepticism, pointing to economic clouds and doubts about whether expectations for fresh monetary stimulus are well-founded.

Traders on the floor of the New York Stock Exchange in July.

The Dow Jones Industrial Average has clocked six straight weeks of gains, rising 9.7% since early June. At 13275.20, blue chips are just shy of their highs of this year and a level not previously achieved since December 2007.

But the gains are getting short shrift from across the market. Some market strategists say the economy remains fragile and corporate-earnings growth is waning. Technical analysts have been seizing on data they say suggests the rally can't maintain its current momentum. And investors have shown their disdain by withdrawing money from stock mutual funds.

"This is the most disrespected rally I've ever seen," says John Buckingham, who manages about $100 million in two equity funds as chief investment officer at Al Frank Asset Management in Aliso Viejo, Calif.

Sluggish trading volumes and continued outflows suggest few investors are eager to hop on board. The main underpinning of the recent move, many investors say, is the belief that the Federal Reserve will announce a new round of quantitative easing to juice the economy, possibly as soon as September. Some investors also are anticipating the European Central Bank will pump money into the region's troubled financial system.

But that belief carries risks, says Gina Martin Adams, equity strategist for Wells Fargo Securities in New York. She says the economy is showing signs of improving, a factor that may prompt the Fed to delay action.

"This rally seems a little premature," says Ms. Adams. "It's based on this idea that the Fed will bail us out." Last week, Ms. Adams lowered her earnings expectations for the S&P 500-stock index, citing slowing growth and a "negative tone" from corporate executives. "I think the Fed's taste for more easing is quite weak," she says.

If the central bankers don't announce new policies, the summer gains could be quickly unwound, she says

In Europe, September will bring new hurdles, including a closely watched ruling by the German constitutional court on the legality of that country's participation in a euro-zone bailout.

Over the past few years, the stock market's rallies have garnered less attention than the declines, in part because they have occurred more gradually. Also, each major rally has ended in steep declines as macroeconomic concerns—from Europe's debt crisis to the slow U.S. economy and China's declining growth—jump back to the fore.

In the first four months of this year, for example, stocks climbed 8.6%. In just four weeks, though, those gains disappeared as Greece and then Spain slid to the brink of a euro-zone exit.

That is in part why trading volumes in U.S. stocks have slumped this year to 6.8 billion shares a day, from 7.8 billion in 2011, according to Credit Suisse's trading strategies team. Nearly $70 billion has been withdrawn from long-term U.S. stock mutual funds so far this year, according to estimates from the Investment Company Institute.

Jim McDonald, chief investment strategist at Chicago's Northern Trust, which manages $704 billion in assets, believes the rally is on firm footing. He bats away fears that Fed hopes are responsible for the rally, pointing to a sharp rise in Treasury yields over the past two weeks. Investors have bid up Treasurys in anticipation of previous Fed actions.

Mr. McDonald also thinks the market may have grown so accustomed to Europe's troubles that investors might even be able to shrug off another flare-up in the debt crisis there.

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