Blue chips seem to defy gravity but a recent rally lacks depth
NEW YORK » If you're wondering what's the deal with the recent run-up in stocks, join the club.
Fears that the economy is slowing rapidly were confirmed yesterday when the government said gross domestic product rose at only a 1.6 percent annual pace in the third quarter, the slowest in three years. Home prices also look to be in a free fall in many areas and central bankers say they're still worried about a reigniting of inflation.
That hardly seems like a combination destined to push stocks ever higher.
But don't tell that to investors who sent the Dow Jones industrial average to new records on each of the first four trading days of the week before it stumbled yesterday after the release of the GDP report. Even so, the blue chip index ended the week up 0.7 percent and more than 12 percent since the recent run started in July.
Some on Wall Street say the stock gains and signs of economic weakness aren't as much in conflict as it would first appear. They point out that corporate profits are on track for their 18th consecutive quarter of double-digit gains, and crude oil prices have pulled back to their lowest levels in 11 months.
Interest rates also are still relatively low, as is the nation's unemployment rate, which means jobs are still plentiful. And a recent batch of earnings from retailers show consumers are still willing to open up their wallets.
"There is a lot of conflicting information out there," said Jack Ablin, chief investment officer of Harris Private Bank. "But it appears the optimistic case has been the right road so far."
Also, the stock rally isn't as stunning as investors might think. Shares of the 30 large companies in the Dow index have risen more than 90 points on only 10 days during the three-month run. The rest of the gains have been more modest, trickling higher to push the Dow over the 12,000 level for the first time.
Moreover, the Nasdaq composite and Standard & Poor's 500 index -- both considered to be better barometers of the market as a whole -- have only advanced about 6 percent and 10 percent, respectively, this year.
"As long as this expansion can keep running, which has been certainly longer than a lot of people anticipated, then the market is going to keep doing well," Ablin said. "Certainly, corporate balance sheets fueled by profitability will provide some kind of ballast in the event the economy starts to sag. Investors are encouraged by that."
There's little doubt the third quarter was another blockbuster period for American corporate profitability. With some 300 of the S&P 500 companies reporting results so far, 74 percent have topped Wall Street analysts' projections, according to Thomson Financial. Only 15 percent have missed expectations.
Howard Silverblatt, editor of quantitative services at Standard & Poor's, said part of the reason most companies are beating forecasts is that revenues rose on average by 16 percent in the quarter, helping to offset a slight decline in profit margins. The third quarter has so far posted a 17.6 percent operating gain among the S&P 500 components collectively, the best period since the fourth quarter of 2004.
But some economists and analysts argue that things aren't nearly as rosy as investors seem to think.
"I think we're seeing a slow train wreck," said Hugh Moore, a partner with portfolio manager Guerite Advisors. "I believe that we're in a twilight time right now; things on the horizon are becoming less and less distinctly visible."
He points out that "if the economy continues this slow, grinding deceleration, then surely profits are going to follow."
Reports this week showing the housing slump has deepened, with inventory levels continuing to mount, could also signal that homeowners may slow the tapping of their home equity to finance their spending.