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Bulls Bid for Another Romp

Robert Holmes

The overarching question is whether the major indices will be able to repeat the generally solid performances of years past, or if uncertainty about the Federal Reserve, the November elections and energy prices will bring out the bears.

Barry Hyman, equity market strategist with EKN Financial, says he's expecting seasonal weakness in September and October. "This pattern shows up in the technical-overbought status of the market as we enter the post-Labor Day season, as well as the upcoming sets of economic data on inflation that we expect would bring the worry back to the market," he says.

Afterward, though, he's looking for strength into the end of the year. "The correction we see, which we now characterize as a potential retest of the bottoms in May and June rather than a bear market correction, is our objective before a rally to finish the year around 1280 on the S&P 500," he says.

Through the first eight months of this year, the Dow Jones Industrial Average has risen 664 points, or 6.2%, and the S&P has moved higher by 56 points, or 4.5%. The tech-laden Nasdaq Composite, meanwhile, has given back 21 points, or 0.9%.

Considering Odds

General Motors(GM) has led the charge on the Dow, up 50% year to date. Fellow components Hewlett-Packard(HPQ), Merck(MRK), AT&T(T) and Disney(DIS) have jumped more than 20% during that same time.

On the weak side, chipmaker Intel(INTC) has lost more than 20% this year. Home Depot(HD) has fallen 15%, and retail giant Wal-Mart(WMT) has dropped 4.4%.

While nothing is guaranteed, if recent history is any guide, the odds favor the long side for what remains of 2006. For instance, through August 2005, the Dow lost 301 points, or 2.8%, and the Nasdaq gave back 23 points, or 1%. The S&P outperformed both, gaining 8 points, or 0.7%.

All three then came on strong for the final third of last year. Both the Dow and the S&P 500 gained 2.3%, and the Nasdaq advanced 2.5%. In fact, in the 10 years prior, the Dow rose eight times between Labor Day and New Year's Eve. During those climbs, it surged by an average of nearly 705 points.

That doesn't mean it's been entirely smooth sailing.

"As we enter September, we can't help but review its dismal historical record," warns Ken Tower, chief market strategist with CyberTrader. "The month of September has risen just 39% of the time during the past 108 years. September's average return of [negative 1.35%] is again by far the weakest return. Clearly, this is a dangerous month for bulls."

Robert Pavlik, chief investment officer with Oaktree Asset Management, wouldn't be surprised to see a decline moving into mid-September and on into October, but he also expects "a pickup in stock prices as we enter November in anticipation of another fourth-quarter rally. However, a rally will be dependent on the economic news, namely inflation remaining in check and economic growth moderating."

During the first eight months of the year, the Federal Open Market Committee, the Fed's policymaking arm, convened five times, raising the fed funds target rate four times by a total of 100 basis points to 5.25%. Amid those rate hikes, the S&P 500 and the Nasdaq touched four-and-a-half year highs.

During August's FOMC meeting, the central bank elected to keep the rate unchanged, adding uncertainty about what it will do for the final three meetings of the year.

Pavlik says the market "will continue to watch for signs that inflation is moderating. The Fed has taken steps in accomplishing its goal of slowing down the U.S. economy and seeing that a so-called engineered soft landing or slowing the economy is occurring, as opposed to a hard landing or recession."

Getting Defensive

Hyman says the bond market is currently signaling a slowing economy. He also maintains that "oil prices could be the wild card for future forecasting of growth and inflation. We currently see the beginnings of a change in momentum players' beliefs of significantly higher prices for crude, gasoline [and] heating oil for the rest of the year."

Then there are the elections coming up in November, which have the potential to affect the strategies of traders.

"The midterm election cycle isn't a focus yet at all, but we'll turn attention to it in September," says Paul Nolte, director of investments with Hinsdale Associates. "It will be a test for the Republicans, as a Democratic Congress, from an investing perspective, brings gridlock to the market. Historically, markets take off when Republicans hold control of Congress. We'd like to take Washington out of the mix."

Considering, then, the potential influences, where can the money be made? On the Dow, Pavlik expects GM, H-P, Merck and AT&T to continue leading the way.

"Sticking with the defensive themes of the year, health care and pharmaceuticals look to be winners," Nolte says. "Telecoms are also rebounding, as they're starting to finally make some gains in sales. They've stopped the bleeding."

Hyman also likes health care, in addition to financials and the technology sector. "At this point, given our forecast for the next few months, we continue to favor large-cap over small-cap as a style choice. Sectors we would put less emphasis on are consumer cyclicals and energy."

Then there's the matter of whether the Dow is poised to set an all-time high in the coming months, and if so, just what that would mean.

"From a physiological point, it does matter," Pavlik says. "It gives investors confidence to buy, and an increase in demand for stocks causes stock prices to rise."

Still, he doesn't expect it to happen by the end of this year. "Even though we are only 400 or so points away, right now the Dow has too many things working against it," he says. The economy is slowing, he says, and companies like General Electric(GE), Caterpillar(CAT) and 3M(MMM) will likely see their earnings weaken.

Hyman agrees that a new Dow record would be an important indicator.

"The major averages, like the Dow, represent the corporate behemoths of the world, and any strength in that sector would indicate that the global economies are performing well and are expected to continue to do such," he says. "It is more of a confirmation of our economy and the implications for our future growth opportunities."