Mixed Signals Generate Cautious Optimism
April was a seesaw month for the financial markets, and for investors. At the beginning of the month, Wall Street was jumpy as the constant coverage of the Iraqi war whipsawed the market. At month end, as the conflict entered the end game, we saw the market’s focus shift to its more usual concerns with economic performance and corporate earnings.
Wall Street reacted positively to encouraging first quarter earnings reports from a broad range of companies, including technology bellwethers like Microsoft and Intel. However, disappointing reports on the U.S. gross domestic product (GDP) issued on April 25 upset this welcome spell of optimism, and stocks retreated as investors took profits from the rallies generated earlier by better-than-expected earning reports. The GDP (a measure of all goods and services produced in the U.S.) rose at an anemic rate of 1.6 percent in the first quarter. Although this rate was higher than the 1.4 percent logged in the fourth quarter of 2002, analysts had expected the figure to be about 2.3 percent. The GDP report together with news that unemployment had reached the highest level this year combined to overshadow favorable data on consumer sentiment and new home sales. The ensuing flurries of profit-taking pushed stocks lower as investors worried that stocks had rebounded too far, too quickly.
Despite this, analysts believe the overall mood on Wall Street has been lifting. Noting that all major averages posted respectable gains in April, many experts see good reason for cautious optimism ahead.
This more bullish sentiment is born out of positive first quarter earnings, lower oil prices and a so-called change in market leadership. Analysts have observed that market leadership—that is the stocks showing strongest performance-- has shifted recently from the relatively conservative value shares, which have led the market over the last couple of years, to growth stocks. Most often, growth stocks are stocks issued by technology companies.
The more bullish analysts see this shift to growth equities—stocks of companies that are faster growing, inherently riskier enterprises—as a strong indication of more optimism on the part of investors and a welcome sign of more aggressive investing.
Bears Urge Caution
Other experts are more cautious and they believe that there has to be a longer period of positive economic and earnings news in order for this upbeat mood to last. Many think that it will not be easy for the Dow to break beyond the 8,500 trading range, but acknowledge that similarly good second quarter results would go a long way towards making this happen. The bears also caution against making too much of recent earning reports, noting that poor performance in the first part of 2002 make it relatively easy for companies to show earning improvements this year. They also note that many corporations were beating only the estimates that they had previously lowered themselves. The bears also recommend that investors look at revenue growth rates –which are not expected to hit 3 percent at many S&P companies—as well as recent earnings.
Whatever their outlook, both bulls and bears recognize that predicting the near-term future is dicey. In the longer term, many believe the size of the deficit and its implications for both inflation and interest rates will be the biggest influence on the financial markets. The final tally for the Iraqi war –expected to exceed the initial $75 billion budget—has yet to be added to the current record $340 billion budget shortfall in 2003 and the $6.4 trillion national debt. Wall Street experts note that the cost of the Iraqi war is imperiling Bush’s proposed 10-year $726 billion tax cut, and that the centerpiece of the plan—the elimination of taxation on corporate dividend, a strategy designed to jump-start the financial markets-- is making little headway in the Senate.
For the next few months, investors are likely to stay cautious and markets somewhat volatile. In uncertain times like these, the smart investor’s best bet is to have, and to adhere to, a disciplined and diverse investment strategy.