MarksJarvis: Analysts second-guess enthusiasm about economy

Many had expected sales, corporate profits to be higher by this point in year

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The stock market is up 19 percent in just seven months this year, and you might think that would put a bounce in investors' steps.

Instead, analysts are second-guessing whether there's a little too much enthusiasm about the economy and corporate profits, and some are suggesting it's time to tone things down a bit.

"I'm worried about the second half of the year," said Byron Wien, vice chairman of Blackstone Advisory Partners.

"The market rally has been fun, but the bill now needs to be paid," noted BMO Capital Markets chief investment strategist Brian Belski.

The Dow Jones industrial average has dropped 140 points from the record high of 15,658 it hit Friday. But the decline isn't because of the threat of a new economic malady. Rather, there's simply ongoing concern that the global economy continues to be weighed down by recession in Europe and joblessness in the U.S.

There's also a sharp slowdown in the emerging markets of Asia and Latin America, which used to be the most powerful engines of growth. And while some analysts see some early signs of improvement in Europe, and stronger housing and vehicle sales in the U.S., the profits of U.S. companies are showing the strain.

Earlier this year, investors thought both the economy and corporate profits would be stronger by now.

"Revenue has been disappointing, earnings have been disappointing, GDP has been disappointing," Wien said. "It's a global phenomenon," and the "economy is suffering from a lack of demand."

In other words, there are too many companies making too many products compared with the ability and willingness of people to buy them, he said. So companies are not hiring.

By this time in a recovery after a recession, unemployment should be about 5 percent, Wien said. Instead, it's stuck at more than 7 percent.

Meanwhile, as corporate profits have been lackluster, the stock market so far this year has given investors the 12th most dramatic gain since 1900.

"For most people, the first 150 trading days of this year surpassed their wildest expectations," Bespoke Investment Group said. "Even more impressive, however, has been the consistency with which the index has traded higher on a daily basis."

Ned Davis, of Ned Davis Research, recently wrote to clients: "I would like to see optimism sober up a little bit more."

Still, Davis hasn't suggested that investors bolt.

"I don't see the market as severely overvalued, but it does indicate moderately high risks," he said in a report to clients. He describes his trading strategy as "mildly bullish, rather than outright bullish."

The Federal Reserve has tried to push investors to take risks in stocks by keeping interest rates so low in bonds that they would need an alternative investment. And the Fed's approach, along with the expectation that the economy would stage a strong recovery in the second half of the year, helped power the rally.

But with the unemployment rate still stuck above 7 percent, and 80 percent of large U.S. companies done reporting their earnings for the last quarter, investors are questioning whether the second half of the year will truly be robust.

In addition, they have begun to worry how the stock market will respond if the Fed starts pulling stimulus away in September. And with the nation's debt nearing the ceiling set by Congress, some analysts worry about another political spat unnerving investors late in September.

Ultimately, the key to stock prices is the profits companies generate. And Wien points out that sales have been so weak that he doesn't see how companies will be able to deliver the profits investors want to see. He only expects sales for the second quarter to be 1.25 percent better than last year's in the same period.

During earnings season the past few weeks, companies from Caterpillar to IBM have disappointed investors as they have noted the difficult environment for generating sales and profits.

The risk in the stock market is that investors have already bought stocks at prices they assumed would make sense for earnings later this year. If those profits don't materialize, stock prices could recede.

Or as Belski said: "The good news is more than fully priced (into stocks) at current levels. Future earnings growth will need to be organic, which is a tall order considering the slow pace of the economic recovery."

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis

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