As market tiptoes higher, bulls see many opportunities

The stealth bull market is back.

After a nerve-wracking mid-May to mid-June slump, the stock market spent most of the summer slowly working its way higher--so slowly that the rebound may have gone largely unnoticed by many investors.

Yet the blue-chip Standard & Poor's 500 index now is less than 1 percent away from its five-year high reached on May 5. Check your own portfolio: You may find that you're doing better this year than you thought.

A lot of things that could have gone wrong in summer didn't. The U.S. economy continued to slow, but it didn't fall off a cliff; the feared global bird flu pandemic failed to materialize; and the Atlantic hurricane season has been mild so far.

Meantime, consider what went right this summer: The Federal Reserve finally paused in its two-year-long credit-tightening campaign; long-term bond yields fell sharply; blue-chip corporate earnings continued their streak of double-digit quarterly growth; and oil prices plunged.

Not surprisingly, stock market optimists believe they have the upper hand as the fourth quarter looms.

"I think you have to work hard to find parts of the equity market that you don't want to hold here," said Ernie Ankrim, investment strategist at Russell Investment Group in Tacoma, Wash.

He says the S&P 500 index could reach 1,425 by year's end, which would be a gain of about 8 percent from its current level.

Key to the bullish outlook is faith that the U.S. economy is experiencing a "soft landing" or "mid-cycle slowdown," meaning a deceleration after three years of strong growth. Implicit in those terms is that this deceleration eventually will give way to faster growth--rather than to a recession and a collapse of corporate earnings.

Fed policymakers raised hopes for a soft landing when they decided at their Aug. 8 meeting to hold their benchmark short-term interest rate at 5.25 percent, after 17 consecutive hikes.

They are expected to stay on hold when they gather on Wednesday. And many Wall Street pros believe that the next change in the Fed's rate will be a cut, perhaps by March.

The bond market certainly is betting on a drop in short-term rates: The yield on the 10-year Treasury note, a benchmark for mortgages and other long-term interest rates, has fallen to just under 4.80 percent from a four-year high of 5.24 percent in late June.

In fact, no matter where you look among Treasury securities -- from three months to 30 years--yields are below the Fed's rate of 5.25 percent. When longer-term interest rates are below short-term rates, that's what is known as a yield inversion. It means rates are upside down.

The bad news of a yield inversion, historically, is that it often has signaled a recession rather than just a slowdown. Paul Kasriel, economist at Northern Trust in Chicago, is in the soft-landing camp. But, he said, "The risks are to the downside," which is what bonds seem to be telegraphing.

"Housing is in a recession and consumers are starting to slow their spending," Kasriel said. In an environment like this, he said, economic accidents can happen.

The International Monetary Fund, the financial and economic watchdog, last week issued its biannual global economic forecast, and estimated U.S. real gross domestic product growth would be 3.4 percent this year and dip to 2.9 percent next year.

But the IMF also warned that "a sharp adjustment in the housing sector would generate strong headwinds for the U.S. economy," jeopardizing overall growth.

If the stock market was seriously confronting the possibility of a recession, it's highly unlikely share prices would be where they are now.

Look what Wall Street has done to home builders' stocks as many of those companies have reported declining earnings this year: An S&P index of 16 major builder stocks has plummeted 35 percent over the last 12 months.

The builders have seen the worst of it, but shifts in the broad market over the summer show that many investors have been repositioning their portfolios for weaker economic growth.

Shares of many industrial and commodity-related companies either have been slow to rebound from the spring sell-off or have continued to fall.

Likewise, small-company stocks, on average, remain well below their all-time highs reached in spring. The S&P small-stock index is 8 percent below its record high set on May 8.

Investors' preference in recent months has been for big-name companies and those whose sales and earnings are less dependent on the economy's strength. Shares of drug giant Pfizer Inc., for example, hit a 52-week high last week.

Still, the market's rebound as a whole has been strong enough to lift the New York Stock Exchange composite index's year-to-date gain to about 8 percent.

That may not be all that thrilling, but if the soft landing is for real, there should be more to come, said Russell's Ankrim. Investors who are afraid of stocks now, he said, "are ignoring a wonderful opportunity."

Tom Petruno is a columnist for the Los Angeles Times, a Tribune Co. newspaper.