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S&P Sputters in Record Bid

Greenspan tracks mud on the rally, but optimism is on the rise among some notable strategists.

Three makes a trend, and the

S&P 500

failed for a third consecutive day to mark a new all-time closing high. The triple play begs the question of whether the blue-chip index can successfully fly this close to the sun.

After spending much of the day in record closing territory, meaning above 1527.46, the S&P 500 slipped 0.1% Wednesday to close at 1522.28. The

Dow Jones Industrial Average

likewise fell back from a potential record to close at 13,525.65, also down just 0.1%. The

Nasdaq Composite

couldn't hold on to its gains either, dropping 0.4% to close at 2577.05.

Many attributed the afternoon selloff to comments from former

Federal Reserve

Chairman Alan Greenspan, who said Chinese stock market is "clearly unsustainable" and that "there is going to be a dramatic contraction at some point."

Others cited technical selling as the S&P 500 hits its March 2000 highs.

"The market hits its inflection points," says Todd Leone, head of listed trading at Cowen & Co. "You get there and the market sells off, so we're working off the overbought conditions here."

For the bears, some of the classic superstitions are falling into place to lend credence to the notion of a market top, but the bullish fundamentals are hard to deny.

On the superstition side of the ledger,

The Wall Street Journal

ran a front-page story titled "This Bull Has Legs." In classic contrarian fashion, some say such an article is almost sure to jinx the rally and push investors over the edge of optimism, ultimately leading into the abyss of skepticism once again.

Also, market gurus are changing their tune, and at least one important skeptical voice has altered course. Last week, Dow Theory guru Richard Russell went from bearish to bullish after seven years, writing to clients that "an unprecedented world boom lies ahead."

Meanwhile, analysts and strategists are rejiggering their forecasts to call for a higher or longer rally.

FTN Midwest's senior equity market analyst Tony Dwyer wrote Wednesday that his 12- to 18-month target on the S&P 500 is 1800, or about 20% higher than current levels. Dwyer's year-end target is 1650, and he is "simply rolling forward" his assumptions.

But those assumptions seem sound, as some cyclically sensitive parts of the market once again rose beneath the surface of major index slumps. The S&P Retail Index added 0.1% as

Target

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posted strong earnings. Target added 1%, as did

Kohl's

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.

Elsewhere in retail,

Dick's Sporting Goods

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also rallied on stronger-than-expected results, although

Dillard's

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tumbled on a 30% drop in year-over-year earnings.

Likewise, some of the transportation stocks that have lagged the market gained ground Wednesday.

FedEx

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jumped 1.5% on the day, helping push the Dow Jones Transportation Index up 0.05%, after having gained as much as 0.7% intraday. Recently the transports have lagged the broad market rather than led it, having failed to make a new high since April 25.

Some of Dwyer's assumptions include the economy experiencing a soft landing or, a midcycle slowdown, instead of slipping toward recession. He notes that this soft landing, like others in 1987 and 1997, happened as growth slows amid weaker consumption.

But the economy remained strong enough to ward off recession due to strong business spending. Also, earnings stayed positive in those slowdowns, as they have so far in this one. In the prior slowdowns, interest rates fell from their peak and stock valuations expanded to reach a price-to-earnings ratio of at least 20 for the S&P 500, he writes.

Dwyer notes that his 1800 call is conservative given his forecast for a P/E of 18 on the S&P 500. If the multiple rose to 20, the price of the index would reach 2000.

Key to the soft-landing thesis is that business spending trends are solid, he writes. Both access to capital and cost of capital remain relatively low as commercial and industrial lending recently hit record levels and is still growing at a double-digit pace, he writes. Dwyer says history suggests it will be another three years before the lending cycle gets meaningfully tight.

Indeed, the risk premiums, or credit spreads, on the most speculative debt in corporate America fell to a record low Wednesday. According to Merrill Lynch, the average spread on a high-yield, or junk, bond is 279 basis points over comparable Treasuries, compared with the prior record of 289 basis points set in August 1997. That suggests investors are willing and able to lend companies money.

Dwyer's confidence in the current business-spending environment may not be shared by every investor, anxiety about which may have helped move stocks lower Wednesday afternoon. If durable-goods orders Thursday come in strong, it'll be the third month in a row. Not to be redundant, but once again, three makes a trend.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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