NEW YORK (Reuters) - To persuade bears that stocks really did hit a bottom during their long summer of discontent, optimists need the market to clear some major hurdles in the next eight weeks, historically its roughest stretch of the year.
As trading volume swells after U.S. Labor Day — for Wall Street, the official end of summer — the well-tanned and well-rested will have to grapple anew with an ongoing credit crisis, a frustratingly uncertain economic outlook and a presidential race that’s heading into the home stretch.
August marked the first monthly rise for the S&P 500 in three months. But because the gains were booked on thin trading volume, it looks hasty to say the selling tide has turned.
The real test, investors say, will come in September and October, typically the worst months of the year for the Dow industrials and S&P 500.
While stocks have staged some modest rallies this month, investors fear it’s going to be tough for the broader market to shake its habit of underperformance in autumn.
For one thing, credit markets are telling an altogether different story. Credit spreads have widened even as much-maligned banking and financial stocks have bounced. What’s more, the future for mortgage market linchpins Fannie Mae FNM.N and Freddie Mac FRE.N, the twin sources for much of the summer’s rocky ride, remains highly uncertain.
“While equity investors are willing to look out toward better times, the bond market has concluded that loans will cost more and that fixed income securities held as collateral at many financial institutions are worth less,” said Gordon Fowler, chief investment officer at Glenmede in Philadelphia.
“We are inclined to believe that the fixed income market may be a little more prescient in this case and that the stock market is going to continue to bounce along at relatively low levels for a while.”
Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, New York, said investors who think banks are through with the worst of their credit-related write-downs, may be in for an unpleasant surprise in the third quarter.
“The comparisons (of year-on-year earnings) are getting easier, because the third quarter of 2007 was a disaster, and you’d think firms would be able to beat them, but they’re not going to.”
Indeed, overall S&P 500 earnings estimates for the third quarter are fast eroding. And while oil prices are below their July peaks, they are still uncomfortably high for consumers and businesses.
On top of that, there’s the U.S. presidential election, which heats up after Labor Day, which could add to volatility.
Meanwhile, U.S. economic fundamentals still look dismal, Johnson said, despite recent data showing gross domestic product grew at a surprisingly robust 3.3 percent clip in the second quarter.
“If you look at GDP, you’re led to believe the economy is solid,” he said. “But if you look at the variables — employment, industrial production and personal income — the economy does not look solid but weak.”
And signs of sluggish growth beyond U.S. borders could spell trouble for a new host of sectors. After reporting a surprisingly steep slide in second-quarter profit this week, Dell Inc DELL.O, the world’s second largest computer maker, warned that companies are cutting back on technology spending worldwide.
Of course, a struggling economy does not necessarily mean stocks have to swoon, as investors have in the past looked ahead to better times.
Giving stock investors some hope that the market may soon shake off the blues is the fact that October marks a year since the major U.S. stock indexes began their downward slump — and, according to data from Ned Davis Research, bear markets typically last just over a year.
In 2002, even before the scandals surrounding Enron and WorldCom were sorted out, markets began to rally their way back into a bull market.
And with financial firms having reported more than $400 billion in credit-related write-downs over the past 12 months, some are hoping things can only get better from here.
“Are the troubles behind us? No,” said Al Goldman, chief market strategist at Wachovia Securities in St. Louis. “But I think we’re in the process of bottoming. Investors are trying to look beyond the valley of myriad problems to better times ahead.”
And while noting that September and October are usually weak months for Wall Street, Delta Global Advisors’ technical analyst Bruce Zaro said he is hoping that the sharp selling that led to the mid-July lows may have flushed out the excesses ahead of time.
Even so, said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio, those looking for a clear end to the bear market and a multi-month rally may be getting ahead of themselves.
“Too many people think it’s a V-shaped situation, where you hit rock bottom and then everything is suddenly great,” he said. “I think there are more hurdles to come. The bottoming process takes time.”
Editing by Leslie Adler