Sliding oil prices and a red-hot housing market helped fuel slight gains for blue-chip proxies this week. But technology stocks remained laggards and the weekly gains could not salvage an April rally that never was. The week brought more evidence that the economy is slowing earlier than expected and that price pressures are picking up; that's sobering news for the stock market facing the possibility of continued Federal Reserve rate hikes, including at next week's policy meeting. Fears of stagflation somewhat abated Friday as the Fed's favored inflation indicator, the personal consumption expenditures index, showed a 0.3% increase in March, in line with expectations. It also helped that labor costs were below expectations for the first quarter. Further evidence of waning consumer confidence and slower growth in the Chicago region were also seen as softening the case for prolonged rate hikes. The data helped the Dow Jones Industrial Average rise 122.14 points, or 1.21%, to 10,192.51. The S&P 500 rose 13.61 points, or 1.19%, to 1156.83, while the Nasdaq Composite gained 17.47 points, or 0.92%, to 1921.65, having touched a seven-month low earlier in the session. Friday's gains were also fueled by an afternoon slide in oil prices and strong earnings from Microsoft ( MSFT - Get Report). Still, major averages were mixed for the week: The Dow rose 0.5% and the S&P 500 added 0.6% but the Nasdaq lost 0.3%. Tech issues were pressured partly by key earnings misses and disappointing outlooks this week from the likes of Amazon.com ( AMZN - Get Report), InfoSpace ( INSP) and STMicrolelectronics ( STM - Get Report). Still, some investors went bottom fishing for blue chips such as IBM ( IBM - Get Report), which had lost 20% since early April before rebounding; Big Blue rose 1% this week. But deep-sea fishing remains a limited field. Amid slower growth and signs of more to come, portfolio managers have been ditching cyclical issues -- including energy stocks -- and continued loading up in defensive issues such as utilities, consumer staples, and health care. Meanwhile, retail investors have been eschewing stocks in general.
In its weekly survey of mutual funds, Merrill Lynch says more money was taken out of U.S. equities than went in, marking the first week that's happened since January. Outflows of $597 million were experienced by U.S. domestic funds while non-U.S. funds continued to see net inflows of $467 million over the past week. Those flows are understandable given the market's weak performance for April, when the Dow lost 3%, the S&P fell 2% and the Nasdaq fell 4%. Despite repeated calls for an "oversold rally" and mostly solid first-quarter earnings, many headwinds are preventing stocks from getting any traction. Most notably, surging oil prices -- prior to this week's drop below $50 per barrel -- are accentuating price pressures while taking a bite out of growth, here and abroad. At the same time, the Fed is trying to return interest rates to normalcy after several years of extremely easy money conditions. The past week reflected these headwinds: Economic growth lost speed in the first quarter, as evident Wednesday when the early reading of GDP came in at 3.1%, down from 3.8% in the fourth quarter and below forecasts of 3.5%. Rising inventories also mean that more growth will likely be shaved off in coming quarters. Slower growth has led to lower long-term interest rates, as measured by benchmark 10-year Treasury note. Its yield has now returned to a two-month low of 4.20%. That should be enough to unnerve Fed Chairman Alan Greenspan, who had called this stubbornly low level a "conundrum" back in February.
Real estate is an obvious candidate for a sector that may have had at least one too many. On Monday and Tuesday, investors received fresh evidence that real estate remains red-hot as both existing- and new-home sales surged in March. Along with falling Treasury yields, that helped stock such as Hovnanian ( HOV - Get Report) rise about 5% and Toll Brothers ( TOL - Get Report) gain about 3% in the week. The Philadelphia housing index gained 2% this week. Emerging-markets investments also have picked up in recent weeks. While a rising fed funds rates should signal the end of the carry trade, Merrill Lynch reports that emerging-market funds, ex-Asia, saw net inflows over the past week, for the second week in a row. While U.S. rates remain a conundrum, there could be more problems down the line. According to Morgan Stanley economist Stephen Roach, the Fed will eventually have to move the fed funds rate to as high as 5.5% to deal with imbalances such as the housing bubble and the current account deficit. That may not come until next year. So far, most economists expect the Fed to hike the Fed funds rate to 3% next week and to maintain a "measured pace" as it watches to see how much the economy slows and/or how fast inflation picks up.