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Abreast Of The Market
Has the Bounce Gone From U.S. Stocks' Step?
From the Wall Street Journal of Sun, 14 Dec 2014 23:27:42 EST

This is the year of sudden tailspins.

In January, April, July and September, U.S. stocks took sharp dives, only to recover and hit new highs. Now they are diving again, with the Dow Jones Industrial Average down 3.8% last week, its worst week in three years.

Many money managers expect another rebound, but the market faces numerous obstacles and, possibly, more sharp swings.

The root cause has been similar for each selloff: soft global growth, creating trouble for investments in commodities, junk bonds and risky stocks. The selling has spilled over to the broad indexes because of investor unease that stock prices are high across the board.

The flash point this time was plunging oil prices, which hurt both stocks and junk bonds issued by energy companies. Europe’s continued growth problems made things worse. Money managers said they saw signs of panic among short-term traders, who sent the Dow down 315 points on Friday to 17280.83, and that made many uneasy.

“Overall, the performance of the markets is very worrisome,” said Krishna Memani, chief investment officer at OppenheimerFunds Inc., which oversees $245 billion in New York. He is particularly concerned about heavy selling of junk bonds, also called high-yield bonds, which has spread beyond energy companies.

He and many other money managers, however, think that the economy is strong enough and the Federal Reserve is supportive enough to keep financial markets out of serious trouble. So despite his concerns, Mr. Memani isn’t selling; he is buying.

Last week’s selloff “may end up being a Christmas gift for investors,” he said, meaning people can buy beaten-down stocks and junk bonds at low prices. He said he is buying junk bonds and corporate loans that he believes have been wrongly caught up in the rush to sell.

Stocks often slump in mid-December. Analysts say investors sell losing stocks to create losses they can use to offset capital gains on tax returns. This year, the selling has been heavier than usual and has involved a lot more than taxes. Still, the Dow is down only 3.8% from the record it hit a week ago, and is up 4% for the year. The S&P 500 is down 3.5% from its Dec. 5 record and up 8% for the year.

Some day, the bull market that has been running since March 2009 will end. And there are plenty of reasons for investors to be nervous today.

The Federal Reserve has indicated it will raise interest rates next year for the first time since 2006. At a policy meeting this week that ends on Wednesday, some investors think the Fed could do away with its long-standing promise to keep overnight lending rates near zero “for a considerable time.” That could occasion more hand-wringing on Wall Street.

European banks had a weak response to the European Central Bank’s December offering of financing, which reinforced concerns that they aren’t eager to lend. Also, Greece’s plans for a December presidential election raised worries the country could pull back from some of its austerity program.

Fears have spread that China could miss its 7.5% growth target this year. Last week a working paper from a Chinese central-bank economist said growth could fall to 7.1% next year, from 7.4% this year. Weakened Chinese demand is a big reason for oil’s drop.

U.S. small stocks also are weak. The Russell 2000 small-stock index is down 1% for the year, which can be an early warning for the rest of the market.

These issues, however, have been around all year. Many money managers have gotten used to them, and to inflated U.S. stock prices.

Stock prices “are getting a little high relative to other markets” outside the U.S., said Dan Morris, global investment strategist at TIAA-CREF Asset Management, which oversees more than $600 billion in New York.

“If we see a correction of as much as 10% over the next six months I wouldn’t be shocked, but I think it will be a temporary thing,” he said, because the economy is recovering and the Fed is supporting economic growth.

He figures the S&P 500 is trading at 16.1 times a weighted forecast he calculates of future earnings for its component companies. That is above the median of 14.6 for that indicator going back to 1987.

Mr. Morris said high U.S. stock prices are justified by low inflation and interest rates, so he doesn’t expect a major stock decline. But he has begun to tilt slightly toward putting new money in Europe and Asia.

While both regions will endure volatility in the near term, he said, they could show bigger stock gains than in the U.S. in the next three years because they will be rising from lower levels.

“Probably my favorite market right now is Japan,” he said.

David Donabedian, chief investment officer at Atlantic Trust, which oversees $25.9 billion, agrees with Mr. Morris on the broad outlook, although he prefers the U.S. market.

“The economic fundamentals here are more attractive than virtually anywhere in the world,” he said. “When the dust settles, we will see we have an economy where growth is better, interest rates are low, inflation is low and the job market and consumer spending are improving. That is a pretty good backdrop” for stocks.

At the same time, because “the market is no longer cheap,” he, too, foresees sharper price swings of the kind witnessed this year. “We don’t think this is a bear market, but it is symptomatic of what we think we are going to see over the next six to 12 months,” he said.

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