Stock Market: Time for Resolution?
The so-called "Santa Claus" rally that elevated the Dow to some of its highest levels this year failed to hold out until year-end as stocks tumbled in response to shifts in the Treasury Market. The catalyst for the Dow’s plunge of more than 100 points was the inversion of the yield curve - the spread between the yields of short-term and long-term bonds. This occurred in late December for the first time in five years, wherein short-term interest rates were higher than long-term rates. Typically, lenders receive higher interest when they commit their money for a longer time period. A sharp increase in the demand for short-term credit can flatten or - as in this case - invert the yield curve. Investors pay close attention to yield curve data because inverted yield curves traditionally have signaled impending recessions.
Is this year-end inversion an important indicator for 2006? Is the outlook ahead bright, or is recession beckoning? As always, opinions vary. Here’s what the bulls and the bears are predicting for the year ahead.
First of all, investment experts note that stock market volume between Christmas and New Year is traditionally light, and that this had the effect of exaggerating the decline precipitated by the bond market. Other mitigating factors include year-end "window-dressing" as fund managers make adjustments to their portfolios before year-end. That being said, experts noted that although an inverted yield curve may not always imply an economic recession, it has predicted profit recessions 100 percent of the time.
Despite ominous rumblings from the bond market, many believe that other economic indicators should chase the gloom away. They believe that pessimism is not supported by current growth rates, and that low tax and interest rates will keep conditions conducive to economic growth. These bulls believe the outlook ahead remains rosy. They note that productivity continues to increase, which helps keep GDP strong and corporate profits high. With this in mind, many Wall Street gurus are predicting sustainable economic growth during 2006 in the U.S and worldwide, and solid stock market performance. Many expect inflation fears to abate as inflation rates settle at around 2 percent.
Most market analysts believe that globalization - especially the emergence of China and India as major economic powers - should be a key factor in investment strategy for 2006 and beyond. With this in mind, many investment experts are looking for market sectors that should benefit most from international commerce and global trade. Possible winners in the service sector include investment banking. While some investment advisors expect companies involved in cargo transportation - commercial aircraft and freight companies - to thrive, many analysts still see opportunities in the energy sector. Oil prices may have peaked but they are still at a range that spur exploration efforts, which means more work for companies providing services and equipment for oil and gas drilling operations. Experts recommend avoiding companies that are struggling to adapt to new technology. Media, broadcasting and music publishing companies, as well as the advertising/public relations and marketing industries are a few that come to mind.
Even the cheeriest optimist concedes that globalization brings its challenges, too. U.S. workers continue to see jobs head offshore and wages remain stagnant as the burgeoning labor supply worldwide drives labor costs down. On the political front, international conflict and crises, as well as terrorist incidents, have the potential to damage investor confidence.
Perhaps the best advice for 2006 is to plan and invest strategically, stay the course, and avoid knee-jerk reactions to news - both good and bad.