The aging bull market may have little fight left in it and is now just sniffing the flowers. Stocks have pulled back sharply in the past 3 months due to signs of economic weakness.
NEW YORK (CNNMoney) — This hasn’t been a fun summer for investors.
Stocks fell in May, June and July. August is off to an ugly start as well. The SP 500 is now slightly in the red for the year following a huge sell-off Tuesday.
At this point, the more than two-year-old bull market seems a lot more like the gentle cartoon character Ferdinand (you know, the bull who wants to sit and smell the flowers instead of fight) than Jake LaMotta (“So give me a stage where this bull can rage!”)
How bad is this mini-crash? The Dow suffered its eighth consecutive loss Tuesday. The last time the blue chip index fell on nine straight days was in February … 1978!
With so many worries about the economy rapidly losing steam, is this the beginning of a market correction? Could stocks even finish 2011 in negative territory?
That is looking increasingly possible.
Stocks surged dramatically from the bear market lows of March 2009 largely on the belief that the worst in the economy was over.
And while few expect another Great Recession — especially now that the debt ceiling deal has removed the risk of the U.S. defaulting — it’s fair to wonder if the rally was too fast too soon. Keep in mind that the SP 500 doubled in just two years.
“When you have a bull market, you want to give it the benefit of the doubt. They usually go on longer and rise further than you expect,” said Barry Ritholtz, CEO of Fusion IQ, a New York-based research firm. “But during the past three months, it’s becoming clear that the economic data is getting softer and softer.”
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The economy isn’t substantially better now than it was two and a half years ago. The unemployment rate is still above 9%. Consumers are starting to spend less and save more. That doesn’t bode well for corporate sales growth.
Lance Roberts, CEO of Streettalk Advisors, an investment management firm in Houston, said he thinks it’s 50-50 whether stocks finish 2011 with gains at this point. Simply put, earnings can’t continue to impress investors if the economy remains stagnant.
“The economy drives profits. Earnings have been decent but a lot has been due to cost cutting. Without sales growth, profit margins may be at their peak,” Roberts said.
That’s not encouraging. While valuations may not be insanely crazy like they were in the height of the dot-com era of the late 1990s, stocks aren’t dirt cheap. The SP 500 is valued at 13 times 2011 earnings estimates.
That’s reasonable considering that earnings are expected to increase by about 10% this year and in 2012. But if profits miss forecasts in the next two quarters, it’s tougher to justify current valuations. And would it really be a surprise if earnings disappoint?
A much weaker-than-expected report on manufacturing activity in July spooked investors Monday. Until then, many investors had been holding out hope that the earthquake in Japan in March would be just a temporary problem for industrial companies.
That no longer appears to be the case. Sluggish second-quarter results and cautious earnings outlooks from the likes of 3M (Fortune 500), Caterpillar ( , Fortune 500) and Illinois Tool Works ( , Fortune 500), seem to confirm that notion.,
“There have been two camps regarding Japan and manufacturing,” said John Derrick, director of research with U.S. Global Investors in San Antonio. “One is that it was an unusual event and now activity should normalize. The other is that there are bigger problems and we should have seen improvement already.”
“I am leaning toward the latter,” Derrick added.
So what can lift the markets out of its funk? Roberts thinks that if stocks drop much further, the Federal Reserve may feel inclined to try a third batch of bond buying, a policy known as quantitative easing.
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Roberts said that QE3 would be a “game changer” that could help stocks rally for the remainder of the year.
But Derrick isn’t so sure. After all, QE and QE2 didn’t do much to help the economy. They just propped up stocks. And the bond market arguably doesn’t need the Fed’s help. The 10-year Treasury is currently sitting at 2.64%.
Making matters worse, Derrick said that he thinks the global market now is viewing the U.S. more cautiously. He argues that there is a growing sense that regulators and lawmakers are either unable or unwilling to help fix the economy’s short-term problems.
“The debt ceiling deal doesn’t exude confidence. It’s still a dysfunctional situation,” he said. “We are not getting the leadership you want from the largest economy in the world.”
Ritholtz is even more glum. He’s worried that the focus on the deficit at the expense of everything else could create another downturn. He said that a few months ago, he pegged the odds of a double-dip recession at just 10%. Now, he thinks the likelihood is 30%.
“If you want a recession after a credit crisis, just stop stimulus. Austerity is another way of saying recession,” he said.
That may be a bit dramatic. But it’s a valid point. Washington is no longer interested in propping up the economy in the short-term. And investors don’t like that at all.
CNN’s Drew Trachtenberg contributed to this report
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.