We've come again to one of those times when Wall Street sits under the Damocles sword. When stocks' rise or fall seems determined by a coin flip.
For some, the market still looks like a very dangerous place. Breadth on the way up was horribly narrow, and the stocks that led the way -- mostly big-cap tech -- still seem filled more with froth than substance. With valuations stretched as they are, here is a time that warrants caution.
"The market is in a very high-risk situation," said Ed Nicoski, chief market strategist at
. "The leaders are overextended and a good portion of this market never participated in the rally to any extent. The majority of stocks are still below their 200-day moving average -- for them, it looks like you've just had a bear-market rally to where they broke down. I don't know where your leadership is going to come from."
There are other worries, too. Things are far from stable in Brazil, and the possibility is being floated that more declines in the real could eventually force a devaluation in China. It is, by most lights, an unlikely event. China carries a trade surplus of about $40 billion. It has $150 billion in currency reserves. It is loath to see the social unrest that would come from a devaluation and the inflation that would follow.
Yet the market was laid low by these same China-will-devalue rumors in the spring even though the chances of a devaluation were extremely low, and these rumors will probably continue to percolate so long as Brazil is still shaky. And Brazil is definitely still shaky.
"Brazil is extremely risky," says Ethan Harris, senior economist at
. "There are very high chances their currency will come apart in a more dramatic fashion." Besides the continued pressure that capital flight is putting on the real, there are now worries that Brazilian companies have run out of dollar reserves. When it comes time to pay off dollar-denominated debt, they will have to sell reals for dollars, hurting the real further.
Brazil Won't Sting Like Russia
Though another breakdown in the real would certainly grab headlines and might spark more selling in global markets, its true effect, says Harris, would be muted. "In terms of the impact if Brazil were to go," he says, "I don't think it will be anything nearly as dramatic as the Russian debt default." The kinds of credit exposures that existed when Russia went simply do not exist anymore. Furthermore, it has not been a secret that Brazil is in trouble -- unlike Asia and Russia, everybody could see this one coming.
"The other thing that's changed," Harris says, "is people have been through a crisis one time, and they've learned that the
is there if there is real trouble."
But while the Fed would ride to the rescue if something happened to the credit markets, Harris points out, it would not ride to the rescue of stocks. That's something Fed Chairman
made quite clear Wednesday in his
testimony before the
House Ways and Means Committee
. "We were particularly concerned about higher costs and disrupted financing in debt markets, where much of consumption and investment is funded," Greenspan said. "We were not attempting to prop up equity prices, nor did we plan to continue to ease rates until equity prices recovered, as some have erroneously inferred."
Should troubles in Brazil spark selling in the equity market, investors should not look for Big Al to come and hold their hands.
So there is a lot to worry about, but as Rao Chalasani, chief investment strategist at
, points out, "If you want to worry, there are always so many things to worry about."
It is a point well taken. A market that gets overbought will grope for reasons to fall. And inevitably, it will find them. But now he feels that digestive process is just about done with. With the rebound off the morning lows on Friday, Chalasani thinks the market has successfully tested the lows it hit earlier this month and is ready to move forward again.
"The market has a good tone to it," he says. "I do believe there is more room on the upside before it's over."
Economic Data Return to the Mix
Bond traders will have their hands full not just watching the stock market (the place they take most of their cues from these days), but also getting ready for a couple of key pieces of data.
On Thursday, the fourth-quarter
Employment Cost Index
-- believed to be the Fed's favorite labor cost measure -- gets released. It should be on the light side, according to Lehman's Harris. "A little bit of moderation on the wage front in spite of the fact that we have a very tight labor market -- that should be a very positive message for the Fed," he says.
But the preliminary fourth-quarter
gross domestic product
release will probably not be the kind of report inflation hawks at the Fed will want to see. It will be very strong -- consensus estimates put GDP growth at about 4%, but Harris thinks it could run as high as 5%.
Part of the reason for that strength is that the winter was very much on the warm side when it began. Crews kept building houses. Appliance makers kept filling them up. The warm weather may have added about 1% to growth.
Another is trade-related. "There tends to be a burst of exports in the fourth quarter," Harris explains. "Most notably in aircraft. These data are supposed to be seasonally adjusted, but obviously the
hasn't fully adjusted the numbers. We think this mini-export boom has also added 1% to growth."
So take away the 1% for the weather and the 1% for the export boom, and you still have underlying growth of 3%. That's still on the strong side.
Put that strong GDP together with the light ECI and one thing is pretty clear: Unless something untoward happens in credit markets, the Fed ain't moving anytime soon.