Did Santa get stuck in Wall Street's chimney?
After three down days in the stock market, investors are wondering if December will bring the gift of continued gains, or if there will be no more joy this year.
Bruce Bittles, chief investment strategist at Robert W. Baird, thinks the typical December Santa Claus rally will show up close to Christmas and make believers out of the people second guessing stocks the past couple of days.
One reason for optimism is that after this year's 25.6 percent climb in the Standard & Poor's 500 index, Bittles thinks investors aren't going to be eager to sell stocks and end up owing capital gains taxes.
Further, Bittles said, December is a winning month in the stock market 74 percent of the time. The fact that investors have had qualms about the stock market the past three days only confirms that the stock market still is not being driven by the blind euphoria that typically comes before a major downturn.
"Stock market tops occur when everyone is happy … happy with stocks and happy with the president," he said. Now, he said, Wall Street is happy, "but Main Street still sees doom and gloom." So he says stocks will climb again after the 183 point drop in the Dow Jones industrial average since Nov. 27. On Tuesday, the Dow fell 94.15 points, or 0.59 percent, to end at 15,914.62.
In a report to clients Tuesday, Bespoke Investment Group also sounded a calming note: "There's been so much 'bubble' talk lately that our heads are spinning. The obvious reason that we're not in a bubble is that so many people are calling it a bubble."
But analysts acknowledge that stocks are becoming more vulnerable. Stocks have climbed more than 160 percent since March 2009, and analysts are debating whether they have become pricey compared to the profits companies are likely to produce in 2014. Stocks can also fall if investors decide they bought based on an illusion.
That's an argument that Bill Gross, chief executive of the Pimco bond fund company, has been making lately. Gross said on the company's website this week that "what keeps us awake at night" is that the prices and values of all investments in the globe have been distorted by the Federal Reserve and other central banks abroad as they've tried to stimulate growth in a fragile economy.
Gross has argued that companies have been able to bolster their profits per share using artificially low interest rates, courtesy of the Fed. With low-cost borrowing, companies bought back shares of their own stock, and that's made profits per share higher than they otherwise would have been. The Federal Reserve is expected to start changing the availability of that low-interest borrowing as it pulls back on what's known as quantitative easing.
When that happens, companies will have to spend more to borrow money, which will make it more difficult to generate profits. And if they are going to grow profits they will have to do it the old-fashioned way — by increasing sales. The trouble is, the globe is still struggling to gain economic strength.
Ned Davis, of Ned Davis Research, told clients in a recent report that he shares Gross' concern. "I am not going to forecast profits, but I do think they have been boosted by a number of factors that are either temporary or unsustainable," Davis said. When trying to determine the actual value of a stock, he added, "I would question how much near-cyclical highs in profits and profit margins are worth."
Those questions are likely to arise more in 2014, as analysts consider when the Federal Reserve will cut back on stimulus. The expectation is that the Fed won't be making any moves until 2014, though the Dow's recent dip came when a stronger-than-expected Institute for Supply Management manufacturing report stoked speculation that the Fed might start tapering stimulus as early as its Dec. 17-18 meeting. Analysts will get a better sense of the Fed's plans if Friday's unemployment report shows stronger employment than anticipated.
Without a surprise move by the Fed, most stock market observers anticipate the strong rally of this year to continue into 2014.
After stocks have climbed 20 percent in a year, they average a gain of 7 percent in the first quarter of the following year, said Anne Mathias, managing director and head of research for Guggenheim Investments.
But Scott Minerd, chief investment officer of Guggenheim Partners, says investors should prepare themselves for a long, sluggish period in the stock market over the next 10 years. He has studied periods when the market capitalization of the stock market is high compared to gross domestic product, and current levels are warning that the stock market is approaching the late stages of a bull market. Over the next decade, he predicts the stock market will average returns of just 2 to 3 percent a year.
Of course, that's an average. Some periods during the 10 years could be strong, and others losers.
"It's not a signal to get out of Dodge," Mathias said. But, she added, it will make sense to manage risk.