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Stock Market Downturn Won't Last: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Before television, the Internet, football, cars and movie stars, Americans were obsessed with baseball. Baseball was the one thing that everyone could talk about with family, neighbors, and co-workers. It became America's favorite summer pastime 150 years ago.

The attraction of a summer day at the ballpark endures, but it is no longer the most common topic of conversation during these early days of summer. Instead, the six-week decline in the U.S. stock market seems to be the topic on everyone's lips. The boys of summer are taking a backseat to the Dogs of the Dow. The big question about the stock market pullback is: What inning are we in?

After six weeks of declines totaling almost 7% for both the Dow and the S&P 500, we believe the stock market pullback is in the middle innings with a few weeks and percentage points left to go. The pressure on stocks is likely to continue for a few more innings because of the following:
  • Soft economic data: Economic data are likely to remain soft in the next few weeks, reflecting the lagged effect of high oil prices, the Japanese earthquake and tsunami, and severe weather and natural disasters in the U.S.
  • Preannouncement season: The so-called earnings "preannouncement season" is coming up in the next few weeks. This is when top executives often preannounce any bad news ahead of second-quarter earnings season, which begins in mid-July.

    For the past couple of years, the preannouncement season has been relatively quiet and not acted as a negative for stocks. However, the slowdown during the second quarter and supply chain problems extending from the disaster in Japan may cause companies to lower their earnings outlooks, giving us more bad news than we've seen in recent quarters.
  • End of QE2: The Federal Reserve is expected to cease being the biggest buyer of Treasury debt on June 30, 2011. That means continued low rates will be dependent upon foreigners stepping back in to buy the increasing quantities of Treasuries. The end of QE2 (Quantitative Easing 2) may heighten concerns about the dollar, interest rates and debt levels, adding to the environment of uncertainty.
  • Debt ceiling debate: The battle in Washington over raising the debt ceiling is likely to heat up in the coming weeks with the threat of a potential U.S. default looming if an agreement is not implemented by Aug. 2.

While these negatives are not new, they may continue to pressure stocks until they begin to recede by mid-July. At that point, we expect that:
  • The debt ceiling debate should be nearing an end.
  • Earnings reports will be getting underway for what should have been another solid quarter for profits.
  • Economic data likely will rebound from the negative effects of the Japan earthquake and tsunami and the unusual weather patterns.

The lifting of these negatives may coincide with an end to the market's pullback and the start of a rebound.

While we do not expect this pullback to extend into extra innings, there are alternative outcomes that could lengthen and deepen the decline:
  • Earnings reports are accompanied by significant downward guidance for the second half of the year.
  • Economic data continue to soften and come in weaker than expected throughout July and August.
  • Europe's debt problems lead to a banking crisis.
  • More bad weather, natural disasters or other unforeseen negative events pose additional shocks to the economy as it transitions away from having fiscal and monetary stimulus.

The season is far from over, and there will be wins to balance out the losses as a volatile, but range-bound, summer ensues. Despite the tough season, stocks are likely to have a winning year. We continue to expect the stock market to post a high single-digit rate of return this year, accompanied by high volatility.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Jeffrey is Chief Market Strategist and Executive Vice President at LPL Financial.

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