Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org NEW YORK — Will the economy make a soft landing, or will it hit the ground hard? ADVERTISING Wall Street is preoccupied with that
NEW YORK — Will the economy make a soft landing, or will it hit the ground hard?
Wall Street is preoccupied with that question now because investors think the result could make or break the stock market in the months ahead.
While it’s true that a recession increases the likelihood of big portfolio losses and lower corporate profits, investors shouldn’t assume that negative economic growth will be the only thing that rocks the market.
New research from Bear Stearns shows that lower equity returns are likely even when economic growth slows in an orderly fashion.
“Soft landing or recession, it’s a lackluster environment for stocks,” Bear Stearns chief investment officer Francois Trahan said.
He draws that conclusion by tracking how the Institute for Supply Management’s leading indicators for the service and manufacturing sectors have correlated with the Standard & Poor’s 500 index in recent years.
In those reports from the Tempe, Ariz.-based research group, a reading of 50 or more indicates economic expansion, while levels that fall below 50 indicate contraction. Trahan believes that a level around 50 is considered a soft landing, while between 40 and 45 is a hard landing.
According to his research, when the ISM’s index historically has come in around 60, then the S&P 500 gains on average 17 percent year over year. A 55 reading has yielded a 5.2 percent average gain, a 50 reading shows a 6.5 percent decline and a 40 reading comes in with a 30 percent average loss in the S&P 500.
The good news is that there isn’t much to worry about on that front just yet: In August, the service sector activity index came in at a level of 57, while the manufacturing index was at 54.5.
Other economic data mostly show a similar picture. While the housing market is clearly deteriorating — with sales and prices growth on the decline in some overheated regions — the retreat isn’t everywhere.
In the April-to-June quarter, economic activity grew at a 2.9 percent annual rate. That was below the 5.6 percent pace in the first quarter — the fastest in 21/2 years — but the second-quarter readings were revised up from the 2.5 percent growth rate that the Commerce Department had previously estimated.
Helping to fuel growth are higher wages, strong corporate profits and growth overseas. Even consumers, who could have pulled the plug on their spending when gas prices jumped to $3 a gallon over the summer, are hanging in. Nonauto retail sales are up nearly 5 percent over the last year.
With growth moderating and inflation not spinning out of control, many economists believe that the Federal Reserve will hold interest rates steady at its meeting later this month. The Fed raised rates 17 consecutive times since June 2004, but stopped at its August policy-making meeting when it held its overnight bank lending rate at 5.25 percent.
Still, the Fed, in its latest survey of America’s business climate released this week, acknowledged some deceleration in growth. It used the word “weak” to describe the economic backdrop no fewer than 50 times in its survey, up from 40 in July and the most since January 2001, two months before the start of the last recession, according to Merrill Lynch.
No doubt the Fed is closely watching each piece of data, and investors should too.
Clearly, focusing on the housing market is a no-brainer. Smart investors won’t just size up what’s happening in residential sales or prices, they’ll also watch how the pullback affects everything from commercial real estate to consumer spending.
Since inflationary concerns are always something on Wall Street’s radar, pay close attention to unit labor costs. They rose at an annual rate of 9 percent in the first quarter and 4.9 percent in the second quarter — both much higher than had been expected. That could indicate that prices are heading up or corporate profits are going down.
And investors should watch how much price-earnings multiples contract. When that happens, it has forecast an economic slowdown 70 percent of the time since 1950, according to Merrill Lynch. The S&P 500’s p/e has already shrunk from 18 times earnings to 16.5 times past earnings this year.
The next two months have been tough on Wall Street in the past. September is known as the worst month of the year for stocks, while October is when some of the biggest market crashes have taken place.
But after that, the strong November through April period begins when the Dow Jones industrials have climbed 7.9 percent on average since 1950 compared with a 0.3 percent gain from May to October, according to the Stock Trader’s Almanac.
At least in that particular case, investors should root for history to be on their side.
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org
