Why Stocks May Have Seen All Their Gains for This Year
A series of daunting events—from renewed tensions between the two Koreas to a flareup in Europe's debt crisis to a growing insider-trading probe of hedge funds—has investors pulling out of stocks again, leaving some pros to wonder if this year's rally is finally over.
Federal Reserve asset buying helped lead a charge that saw the market gain 17 percent from Aug. 26 to Nov. 5, two days after the central bank announced the second phase of its so-called quantitative easing program.
But the market has clearly cooled off since then. The Standard & Poor's 500 has fallen roughly three percent, though it still is up over seven percent for the year.
With praise for QE-2 turning to harsh criticism, Europe's debt problems rearing their head and new hostilities between North and South Korea, investors are reluctantly coming to grips with the fact that there are significant headwinds in the markets.
"Based on momentum and sentiment extremes achieved at the nearby highs, it seems likely that the stock market will be on a declining path, at least through year-end," David Rosenberg, economist and strategist at Gluskin Sheff in Toronto, wrote in his daily analysis.
Rosenberg cited five factors conspiring against the markets: China monetary tightening amid inflation fears; a rescue plan for European debt not working; fiscal austerity in the US with the political change coming when the new Congress takes over in January; gasoline price hikes; and questions over whether a slew of tax breaks will be extended.
An intensification of even a few of those factors likely would further dampen investor enthusiasm for the market.
"Most pundits believe we are in a cyclical bull market but that is not the case—it has been a sideways market now for over a year," Rosenberg said. "Moreover, after testing support in July, the market hit resistance levels in November, so it would seem logical to expect the index to make a run at the low end of the range. The only question is whether support will hold up once again."
Investors had been waiting for the Fed's Nov. 3 decision as well as the national election results for more certainly about the course ahead.
But even though the market got what it wanted with a Republican victory and the prospect of gridlock, along with a $600 billion QE program, other concerns quickly clouded the landscape.
The chief worry among many market pros seems to be the European debt issues in countries such as Ireland, Greece and now Portugal. Along with creating global financial instability, the crisis also has sent investors into the safety of the US dollar, the rise of which has been a negative trigger for the stock market.
"Sovereign debt is the wild card," said Art Hogan, managing director at Jefferies. "If we bounce from Ireland to Portugal to Spain and the dollar firms up at every level, then I think it's going to be very difficult for equities to catch a bid here."
Markets have behaved much like they did in April when sovereign debt worries first surfaced and stocks stumbled through the summer, prior to the rebound. The market is beginning to take more serious notice of the problems in Europe.
"Ireland could weigh on things a lot more than people think. They're still dismissing it," said Kathy Boyle, president of Chapin Hill Advisors in New York. "Unless you have someone close to you in distress, the view is still rose-colored glasses."
Closer to home, investors have to grapple with worries over whether problems with mortgage documents will cause banks to deal with putbacks—or the need to repurchase securities sold under fraudulent circumstances.
"We came into earnings season with the mortgage putbacks as top priority for the banking space," said Justin Wiggs, vice president of trading at Stifel Nicolaus in Baltimore. "People are starting to digest the fact that putbacks aren't going away and are going to be a drag on earnings for a couple of years."
To be sure, there are things to like about the market.
Analysts at Nomura Securities pointed out in a note to clients that a surge in stock prices often acts as a leading indicator for holiday shopping—that is, rising stocks make people feel like they have money which they will spend at the stores.
Hogan said clarification on tax issues hasn't been priced into the market and could provide a boost should Congress continue the majority of tax cuts set to expire.
And most of all, the market has only pulled back 3 percent after a 17 percent surge, which Wiggs said shows some strength.
"It's sputtering," he said of the market. "A pause here is probably healthy for the markets."