How to cheer up the market By Alexandra Twin, CNN/Money Staff Writer CNN Money | April 5, 2005 http://money.cnn.com/2005/04/05/markets/markets_outlook/ Oil and rate worries have investors running scared. What will it take to coax them back into stocks? NEW YORK (CNN/Money) - Imagine for a moment the mythical world of Happy Stock Land. The economy is chugging along at a good pace that's not overly inflationary Corporate earnings are strong enough to reassure CEOs and spark hiring Companies enjoy some, but not too much, pricing power The Fed communicates clearly about the pace of rising interest rates Bond yields stay low, making stocks more attractive Crude oil is less than $40 a barrel In some ways, the current stock market isn't that different from the ideal world for investors described above. But the prospect of oil staying well above $50 a barrel -- Goldman Sachs forecast last week that prices could hit $105 in coming years - - and a pickup in inflation have been more than enough to shatter the daydream. That helps explains why the market has struggled, even as the economy grew at a solid 4.4 percent clip last year while corporate earnings jumped 20 percent. From the end of March 2004 through the recently ended first quarter, the Dow industrials gained just 1.4 percent and the Nasdaq composite barely budged. The broader S&P 500 did somewhat better, rising 4.8 percent. "The market should be up," said Douglas Altabef, managing director of Matrix Asset Advisors, a New York money management firm. "There should be an upward move because of the economy and the health of Corporate America. (But) what's stopping us is the specter of inflation and higher rates -- and the direction of oil prices." So early in the second quarter, here's a look at why the market may bounce back -- but also, in the current nervous environment on Wall Street, why it may not. Oil pulls back Higher energy prices hurt corporate profits by raising the cost of doing business, and they also act like a tax on consumers, cutting into discretionary spending. "The situation would be turned on its head if oil prices were to suddenly tumble to $35," said Stephen Leeb, president at Leeb Capital Management. "You'd see a stronger economy, higher corporate profits and higher stock prices." "The problem is I don't think you're going to get that kind of break," Leeb added. "There's no way supply is going to keep up with demand." While most analysts agree that oil is unlikely to fall sharply, beyond bouts of profit-taking here and there, they disagree about how the growing world economy will handle the increased demand. Michael Darda, chief U.S. economist at MKM Partners, said that rising oil demand should lead to higher production, which could mitigate further price increases. And because of improvements in technology and productivity, higher oil prices in general aren't as bad for the economy as they were during the 1970s oil crunch, for example. The Fed makes it clear It's well understood that the Federal Reserve is going to keep raising short-term interest rates, and that consumers are already feeling the pinch of inflation and higher rates every day. Stocks are anticipating the pinch, too -- equities traditionally have a tough time in a rising rate environment and the market has been struggling. But what would make the prospect of rising rates more tolerable would be if the Fed gets clearer about the pace of hikes. Uncertainty about this has riled stock and bond markets of late. At the last meeting, the central bank boosted the fed funds rate, a short-term bank lending rate, by a quarter-percentage point to 2.75 percent, the seventh hike since last summer. In its statement, the Fed said it would probably raise rates at a "measured" pace, but also discussed rising inflation and pricing power, sparking worries the pace of hikes may speed up. But those fears are probably overdone, said Donald Selkin, director of research at Joseph Stevens, adding it's unlikely the Fed would get more aggressive due to the stock market's recent weakness -- which could be forecasting a slowing economy -- higher oil prices, and mixed economic numbers of late. "I think if they take out the language about inflation, as well as leave in the 'measured' (at future meetings), that will calm the market a bit," Selkin added. MKM's Darda agrees that worries about rising rates are overdone, noting that even if the Fed funds rate ends the year as high as 4 percent, that's still not far from historic lows. Earnings: still good Stock investors have also been bothered by slowing earnings growth. However, those concerns may also be overstated, some analysts say. After big gains in 2003 and 2004 -- which followed several tough years -- earnings growth in 2005 will look slower by comparison. But growth will still be solid, and come in above the historic average, said Thomson Financial research analyst David Dropsey. Currently, analysts are forecasting year-over-year earnings growth of 8.1 percent in the first quarter, 8.7 percent in the second quarter, 13.7 percent in the third quarter and 11.6 percent in the fourth quarter. Actual results typically come in higher than forecasts. Historically, earnings on average have grown at a 7.6 percent rate in any quarter, so the outlook for the first quarter and beyond is still very strong. For the full year, earnings are expected to grow 10.8 percent, versus the historic average of 7 percent. Other factors Traction on Social Security reform, or making permanent some of the tax cuts passed in 2003, could also provide a catalyst, MKM's Darda noted. In addition, huge pools of money in private investment funds could have a beneficial impact as well as the year wears on, said Matrix's Altabef. "It represents an alternative source of shareholder value building," he added, noting the recent buyout of SunGard Data Systems as an example. Additionally, public companies will likely put more money into mergers and acquisitions, which could help stocks too. "I think momentum is going to slow down, but I don't think markets are going to be as defensive as they were in the first quarter," said Subodh Kumar, chief U.S. investment strategist at CIBC World Markets. "There is room for the market to recover." ------------------------ Yahoo! Groups Sponsor --------------------~--> Has someone you know been affected by illness or disease? Network for Good is THE place to support health awareness efforts! http://us.click.yahoo.com/RzSHvD/UOnJAA/79vVAA/NJYolB/TM --------------------------------------------------------------------~-> �������������������������������������������������������� This is ZESTEconomics. Post economics-related articles and event info to [email protected] If you got this mail as a forward, subscribe to ZESTEconomics by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! 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