On the surface, Thursday's equity rally seemed another example of
bullish resistance to negative news, including an unexpected spike in weekly jobless claims and overriding concerns about valuations, economic growth, and terrorism. In reality, there were some honest-to-goodness positive developments for shares, including congressional agreement on a tax cut and the United Nations' lifting sanctions against Iraq, which helped push crude futures down 0.6%. In addition, the forthcoming Memorial Day weekend may have given some heavily shorted stocks and sectors a boost, as traders squared up positions in anticipation of the holiday. For example, the Amex Biotech Index rose 4.1% and the S&P Homebuilding Index jumped 6%. Major averages rose steadily throughout the session before fading a bit in the final 30 minutes of trading. The Dow Jones Industrial Average closed up 0.9% to 8594.02 vs. its intraday best of 8628.14, while the S&P 500 gained 0.9% to 931.87 after trading as high as 935.30, and the Nasdaq Composite climbed 1.2% to 1507.55 vs. its apex of 1512.80. The final-hour fade somewhat undermined the significance of the rally, as did market internals. At 1.45 billion shares on the Big Board and 1.7 billion over the counter, trading volume was solid, but not huge, while market breadth was not exceedingly positive. Gainers led 2 to 1 in New York Stock Exchange activity and by 19 to 12 in Nasdaq trading. Such technical glitches notwithstanding, some traders suggested the advance harkened a return to the upward momentum of the five weeks prior to Monday's sharp setback and two days of sideways action thereafter. (Bears, naturally, contend this is the "last gasp" of a rally that effectively ended with the intraday highs hit last Friday by the Dow and S&P, and on Thursday by the Comp.) The veracity of such views remains to be seen but (as mentioned above) there were some upbeat developments. Chief among them was expected congressional passage of a roughly $350 billion package that lowers but does not eliminate taxes on both capitals gains and dividend taxes, with so-called sunset provisions. (As theorized here , dampened expectations regarding dividend tax relief may have made its actuality a bullish development.)
The plan is being criticized both as insufficient -- it's less than half of President Bush's original proposal -- and as unnecessary and overzealous given rising federal budget deficits. The Wall Street Journal (no "liberal rag" by any stretch) had two stories Thursday about how the plan is rife for tax-avoidance by wealthy individuals. Almost everyone agrees the sunset provisions and different rates for various tax brackets make the plan overly complex. But on Wall Street, some tax cut is better than no tax cut. "The fact we got something on dividends and lowered capital gains is a positive although not as much as the full dividend piece" would have been, said Liz Ann Sonders, chief investment strategist at Charles Schwab and among those who met last month with the president to discuss the plan. Sonders was "neutral to slightly optimistic" about the expected package from Congress, wondering if investors and corporations will change their approach to dividends given the plan is to be phased in and then expire in 2008, as currently written.
translates into better consumer spending," Sonders said. "The wild card is still capital spending but I do think we're underestimating that." American corporations have done so much cost-cutting and restructuring -- which has boosted bottom-line earnings -- that they may soon "start spending to maintain productivity and earning leverage," the strategist theorized. Instead of focusing solely on cutting near-term costs, managements may "finally start looking ahead" and begin making more "strategic investments," she said.
Melting Pot of PositivesHowever, the strategist "feels good about the market," in part because of the tax cut but more because of an "amalgamation of other things." This amalgamation includes recent evidence about increased confidence among consumers -- notably the recent University of Michigan index -- and business executives, as per a recent survey by the National Association of Business Economists. "I'm getting a sense you're in a 1991 environment where confidence surveys saw significant jumps because of the end of war, and do think that
This, too, remains to be seen. But Sonders noted corporate profitability has gone from a decline of 22% 18 months ago to a rise of about 11% in the first quarter. "Maybe it's
largely from cost-cutting but you have seen profits improve at a pace that's historically pretty powerful," she said, further arguing low capacity utilization and rising unemployment are historically lagging indicators in economic recoveries. Regarding employment, weekly jobless claims rose to a higher-than-expected 428,000 for the week ended May 22, the 14th straight week above 400,000. In part because of the jobless data, and in part because of rising speculation, the Federal Reserve may buy long-dated Treasuries. The price of the benchmark 10-year note rose 20/32 to 102 18/32, its yield falling to 3.32%. The dollar dipped to 117.22 yen in late New York trading from 117.27 yen Wednesday while the euro rose to $1.1693 from $1.1678. We didn't discuss the dollar but Sonders didn't seem too concerned about recent strength in Treasuries, which many suggest portend further economic weakness. She attributed much of the recent rally to "massive inflows" from retail investors, historically not the best market-timers, and suggested yields probably "don't have that much more room on the downside." As for valuation concerns, the strategist said low inflation is supportive of higher price-to-earnings ratios, noting that when inflation has been under 2% P/Es have historically been around 22. Thus, the market is currently "fairly valued" in her estimation. (On related note, oft-bullish fund manager Kenneth Fisher observed the dividend yield of the S&P 500 is now above 10-year Treasury yields -- based on forward earnings projections. "Stocks aren't expensive," Fisher declared in the current issue of Forbes.) Other positives Sonders cited included a better technical tone to the current rally vs. prior ones since the peak, most notably expanding breadth, and diminishing "competition for returns" from money market funds and Treasuries. Aalthough she described her case as "relative optimism" vs. unfettered bullishness, Sonders didn't seem worried about much Thursday, accurately reflecting the broader market itself.