The third quarter could fade quietly away in the week ahead, as markets look forward to a more dramatic fourth quarter, with the election and pending "fiscal cliff" making it the trickiest period of the year.
The approaching quarter-end Friday could bring some portfolio adjustment as investors look to lock in some gains in a year where the stock market’s 16-percent rise has surprised just about everyone. In the coming week, there are data on housing, the economy’s one brightening spot, and the consumer. There should also be more companies issuing pre-announcements on earnings, as the global slowdown holds back revenue growth and bites into profits. (Read more: Why FedEx Profit Warning May Be Bad Sign for Stocks)
“The market really heats up , in terms of market-moving events in the first week in October, when we have the unemployment report, the presidential debate, and the euro-zone finance ministers meeting. You get the beginning of the earnings season, and there’s a little more trepidation than usual as to what the earnings season could look like,” said Leo Grohowski, CIO of BNY Mellon Wealth Management. Earnings for the S&P 500 are expected to be down nearly 2 percent after a less than one percent gain in the last quarter.
Janney Montgomery chief investment strategist Mark Luschini said there could be some late-quarter buying by fund managers who are trailing the index gains. “I think it’s always a little choppy around that window-dressing period, but for this one with so many lagging, I think that could bias the market higher,” he said.
Stocks finished the past week flattish but the S&P 500 at 1450 is up 3.8 percent for the month and 7.2 percent for the quarter. The Dow ended the week at 13,579, down 13 points for the week. It is up 3.7 percent for the month and 5.4 percent for the year.
“I don’t think investors should extrapolate out this wonderful summer and just assume we’re going to have a wonderful fall,” said Grohowski.
Focus will remain on the Mideast and specifically Iran’s nuclear program in the coming week, as the U.N. General Assembly meets, starting Tuesday. Europe will also stay in the headlines, as investors watch to see whether Spain will finally make a request for aid. (Read more: Spain Nears Bailout—But What's Different This Time?)
“Obviously, if Spain comes forward and actually asks for a buyout formally and succumbs to whatever conditionality there is, I think that could be an additional catalyst for equity prices,” said Luschini.
But the market needs a bigger catalyst to keep it going. “I think for equity prices to get much better, I really think we need to get some validation coming from the economic fundamentals,” he said.
Grohowski, and other strategists, see the market as overdue for a pullback after its summer run. “I just don’t think it’s going to be this easy, smooth sailing between now and the election. I’m just a little more cautious,” he said. Grohowski expects to see a three- to five-percent pullback in the near future.
The "fiscal cliff" is the one-two punch to the economy that could occur if Congress doesn’t act on expiring Bush tax cuts, and the more than $100 billion in automatic spending cuts that will start Jan. 1, as part of the debt ceiling deal. Goldman Sachs economists said Friday that if the economy hits the cliff, and there are no adjustments to the expiration of Bush-era tax cuts, disposable income would be reduced by more than 4 percent in early 2013, with the biggest impact on the lowest and highest income groups.
If the tax cuts expire, income-tax brackets would go from the lowest at 10 percent and the highest of 35 percent, to a low 15 percent and high 39.6 percent.
Year-end tax selling could take on new meaning, if it looks like Congress will let the Bush tax cuts expire. “I think people understand their dividends are going to be taxed differently, but many of them don’t understand the magnitude of that jump,” Grohowski said. The wealthiest Americans could pay 43.4 percent on dividends, instead of the current 15 percent, because a new tax that came with health care legislation taxes certain types of income at a rate 3.8 percent above the income tax rate.
“I think there’s a 50-percent chance we hit the cliff,” he said. Grohowski said that makes already pricey dividend stocks like utilities, REITs and MLPs less attractive.
Luschini said the market should start to focus more on these concerns. “October is all about the election,” he said. “I think as we draw close to the election, it’s going to take a more critical role in determining the direction of the market. I think the market has started to appreciate a little more the possibility of a fiscal cliff, but not the probability.” Luschini said the presidential debates could highlight the cliff in the minds of investors, particularly if the candidates come off as obstinate and unwilling to compromise. (Read More: Obama Leads Romney in Three More Swing States: Polls)
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