The ingredients for lifting the market's gloom are at hand, strategists say. But they disagree on just what combination might do the trick.
Despite Tuesday's rally, the
Dow Jones Industrial Average
is down more than 6% over three months. Observers concur that higher oil prices, rising interest rates and the messy occupation of Iraq have put stocks in a funk. They contend that reversals of those negative trends -- or even investors' acceptance of those risks -- eventually will push the big market indices higher again.
But while reassuring news in these areas will help the market, it's still not clear which of these elements will have the biggest positive impact. One argument points to oil prices as the most important variable affecting the market's health, while another indicates interest rates. Of course, as with so many other parts of the economy, these two are intertwined, making the answer far from simple.
"Oil is the key driver," argues Joseph Quinlan, chief market strategist at Banc of America Asset Management. Oil is "the global impulse that's driving the market right now," he says.
A pullback in oil prices, says Quinlan, would reflect less violence in the Middle East, increase output from the OPEC cartel and lower geopolitical risk. That, in turn, would ease concerns about lower global growth next year and higher inflationary pressures.
Crude oil futures traded at $40.42 Tuesday, up about 50% from last September's lows.
The longer oil prices stay above $40 a barrel, says Quinlan, the greater the risk of slower global growth six to 12 months out, and the greater the prospect of an accompanying deceleration in earnings. Quinlan says he suspects that oil will hover around $40 until there's greater clarity about the scheduled June 30 transfer of power in Iraq from the U.S. to an Iraqi government.
Scott Wren, senior equity strategist at AG Edwards, puts oil and Iraq further down on his list of forces affecting the market, behind inflation worries and investor scrutiny of the
Federal Reserve Board
Investors want to know whether the coming inflationary spike will be big or small, and they want to be sure that the Fed doesn't slow the economy's growth by cranking up interest rates too far, says Wren.
Over the next few months, Wren says he believes core consumer price index numbers will rise from the neighborhood of 1.6% to 1.7%, on a trailing 12-month basis, to a range of 2% to 2.5%. The Fed, he believes, could raise interest rates a quarter-point in June and maybe another quarter-point in December.
Wren says he suspects it will take six to 12 months for investors to acclimate themselves to an environment of higher interest rates, and to reassure themselves that earnings and the economy will grow. After this period of consolidation, as he puts it, the stage would be set for the market to go higher.
A fall in the price of oil, perhaps from an increase in OPEC's production, could shorten the consolidation process, says Wren -- but he doesn't think that scenario is likely.
Good news from Iraq would boost the market, says Wren, but that effect would likely be short-lived.
Meanwhile, Hugh Johnson, chief investment officer of First Albany Capital, imagines that it will take a confluence of good news and lower prices for the market to rebound.
"Usually, it's a combination of events that conspire to re-energize the stock market," Johnson says.
The first and most important factor, he says, is that the stock market has to reach a price that is "arguably cheap." If the market, which he terms "fairly valued" right now, were to drop into the 9000 to 9500 range on the Dow, he says, that would be "dirt cheap." But, he adds, "The market is never accommodating, so it'll never get there."
Anyway, at some point, says Johnson, oil prices and interest rates will decline, and there will be some good news out of Iraq and/or China. "Events will come together, and we will reach that so-called magical moment," says Johnson.
Exactly when that moment will be, Johnson isn't predicting. It could happen in months, he says, or "it could happen in a day."