July 31, 2013
This is a week of clues, with economists and investors watching for signals that the economy and stock market are ready to stand on their own with less help from the Federal Reserve's pacifying bond-buying program.
Stock investors reacted nervously in May when they thought the Fed was getting ready to stop indulging the markets with continued stimulus. U.S. stocks fell about 6 percent and mortgage rates got more expensive when Fed Chairman Ben Bernanke hinted that the Fed would start pulling back a little on bond buying aimed at keeping rates low.
Although no date was provided, investors assumed the pullback would start in September. But the immediate reaction was so intense, Fed officials worried that the housing recovery would stumble and a stock market slump would undermine the economy's recovery. In response, Bernanke returned to the bully pulpit to assure the markets he'd be willing to do more coddling if the economy seemed to need it. Stocks climbed again.
This week, investors will get insight into whether stocks might be shaken anew as the Fed speaks again about its plans and the economy shows its underbelly. After a two-day session, the Federal Reserve's meeting will culminate at Wednesday with investors weighing every word for hints that the days might be numbered for the Fed bond-buying that has fueled an 18 percent climb in the stock market this year. An array of economic data, starting with the nation's gross domestic product Wednesday and ending with the unemployment report Friday, will provide a glimpse into the strength of the economy.
With no news conference scheduled after the Fed meeting, most economists do not expect any announcement about an immediate end to the Fed's stimulus. Nor are they expecting the economy to send signals that will prompt the Fed to cut stimulus now.
"Recent incoming data have suggested that second-quarter GDP growth could be particularly disappointing, with a sub-1 percent reading possible," said Paul Ashworth of Capital Economics. That's even weaker than the 1.8 percent pace of growth in the first quarter.
Unemployment, too, is expected to remain stuck near recent high levels. Citigroup economist Robert DiClemente expects the unemployment rate Friday to improve slightly, to 7.5 percent from 7.6 percent. That's significantly above the 6.5 percent Bernanke has said would free the Fed to ease stimulus.
Still, many economists think the Federal Reserve will start to ratchet back some bond buying starting in September, even if the economy is lackluster, because some think stimulus has gone on too long and is igniting speculative bubbles.
Before the Fed's comments in May, analysts had worried about speculation in high-yield bonds. That speculation cooled when the Fed suggested it was getting ready to provide less stimulus.
The combination of less stimulus and a weak economy could be risky for high-yield bond investors. Weak companies, facing trouble selling products and also unable to access low-interest loans, could face struggles and default on payments to bondholders.
Investors have reason to be concerned about high-yield bonds, notes Moody's economist John Lonski.
"The outlook remains soft," said Lonski, noting the "woeful performance" of GDP. "After all, the U.S.' current recovery has just entered its fifth year, and not since World War II has nominal GDP growth fared so poorly in the fifth year of a business cycle upturn."
Yet, despite weakness in the U.S., other areas of the world are more troubled. China's economy is slowing and Europe is in a recession.
Said market strategist Ed Yardeni: "While growth has been subpar in the U.S., it has been more resilient than in most other countries, especially European ones."
That has caused companies that sell products overseas to remark repeatedly during earnings season that sales abroad have suffered. Caterpillar recently emphasized the concerns.
Analysts think stocks could face some volatility in the months ahead, as investors worry about the Federal Reserve's next move and lackluster profit growth among U.S. companies.
"The weaker trend in economic data raises the prospect that corporate earnings estimates may need to be scaled back," said Russ Koesterich, BlackRock's global chief investment strategist. "This scenario creates a potential risk for U.S. stocks."
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