Saturday, July 6, 2013

Stock rally's fate hinges on 4 questions

The U.S. job market continues to heal, putting Wall Street on a collision course with an inevitable shift to a less market-friendly Federal Reserve and raising fresh questions about what comes next for stocks.
The changing dynamic between the Fed and markets could determine the fate of the stock rally. It also sets up a titanic tug of war between growth-sapping higher interest rates and a somewhat-fragile economy trying to prove it can stand on its own.
While the fact the economy created a better-than-expected 195,000 jobs in June is good news, the optimism is being tempered by the belief that the hiring surge gives the Fed a legitimate reason to start "tapering" its "easy money" bond-buying program later this year, perhaps as early as September. The policy, dubbed "QE" and designed to keep borrowing costs low, has been a boon for stocks.

Stocks are also being pressured by the bond market, where the yield on the 10-year Treasury note on Friday spiked above 2.7%, a level not seen since August 2011. The soaring yield raised fears that interest rates will move sharply higher and jeopardize the rebound in housing and dent overall growth. Still, the Dow Jones industrial average rose 1% Friday to 15,136 and is just 1.8% off its record May 28 high.
For stocks to continue rising, the economy must prove it can overcome the dampening effect of less Fed stimulus and rising rates, says Quincy Krosby, a strategist at Prudential Financial.
"If you're going to have tapering, on the other side of the equation you better see economic growth gain traction," says Krosby.
How stocks fare could be determined by answers to four key questions:
1. How will investors react to the Fed's "taper" timetable? More clues come Wednesday with the release of minutes of the Fed's June 18-19 policymaking meeting and a speech by Fed Chairman Ben Bernanke.
"We know tapering is going to happen. So what does it look like?" says Russ Koesterich, global chief investment strategist at BlackRock. "Investors want to get a feel for timing. They're also curious about the strategy and different forms of tapering the Fed is considering."
2. Will CEOs paint a bright earnings outlook? The second-quarter earnings season kicks off July 8 with reports from aluminum giant Alcoa and big Wall Street banks, including JPMorgan Chase.
"Analysts will want to hear confirmation from corporate leaders that they are seeing the same signs of economic improvement that the data seem to suggest," says Russell Price, senior economist at Ameriprise Financial.
3. Will bond yields stabilize or shoot higher? A spike to 3% or more on the benchmark 10-year Treasury could rattle investors anew.
"How problematic (rising rates) become depends on the magnitude of the increase and how fast they get there," says Price. "We'd like rates to rise at a measured pace that allows the economy to continue its recovery."
4. Will global hot spots cool? Geopolitical risks are back. The political crisis in Egypt, the latest flare-ups in the eurozone's debt crisis in and ongoing questions about whether China's economy will slow are potential setbacks for stock investors.
"We got lucky in the first half," says Koesterich. "A lot of things that could have gone wrong abroad did not. But none of the issues have been fixed."


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