Bullish to bearish and back, in a flash
The price of U.S. Steel Corp. stock says the economy is healthy.
Prices of most home builders’ shares say it isn’t.
The price of gold says some investors aren’t sure what to believe and figure it’s a good time to buy some insurance.
Confused? You’re in good company. The first quarter of the year was all about divergences in financial markets. Consensus was hard to find, or at least it was after stocks tripped badly in late February and early March on nervousness about the economy.
The mess in the mortgage market, amid rising defaults by sub-prime borrowers who can’t make their payments, was the big shock to Wall Street in the quarter ended Friday -- although some investors might say the only real shock was that anyone would be surprised that many recent home buyers were in over their heads.
In any case, the potential for spillover from the ailing housing sector to the rest of the economy became Topic A in markets these past three months.
Faith that the U.S. economy in 2007 could achieve a “soft landing,” meaning a temporary slowdown that would give way to stronger growth in 2008, began to dim. Fear of a housing-led recession ramped up.
That sent some investors into defensive mode, away from high-risk securities and toward stocks and other assets that might hold up well in a contracting economy.
Hence, shares of utility companies attracted buyers. Even in a poor economy, “people like their power to stay on,” said Jack Caffrey, equity strategist at JPMorgan Private Bank in New York.
The Dow utility stock index jumped 9.5% in the quarter. The sector also got a boost from an unexpected $33-billion takeover offer for Texas-based utility giant TXU Corp. from buyout firms Kohlberg Kravis Roberts & Co. and Texas Pacific Group.
Jam maker J.M. Smucker Co. also seemed like a safe bet to some people. The Orrville, Ohio-based company’s stock rose 10% in the three months, closing Friday at $53.32.
U.S. Treasury bonds, the classic defensive investment, were popular. Demand drove the bonds’ prices up and their yields down. The yield on five-year T-notes ended the quarter at 4.54%, down from 4.69% at year’s end.
For bearish investors, the late-February global stock market slump was exactly what they’d been hoping for. It was a giddy moment for “short sellers,” traders who borrow stock and sell it, hoping to buy it back at a lower price in the future and pocket the difference between the sale price and the repurchase price.
The blue-chip Standard & Poor’s 500 index dropped 5.9% from Feb. 20 to March 5. The technology-dominated Nasdaq composite index sank 6.8% in the same period.
Those weren’t dramatic losses, but the bears ran wild anyway. By mid-March the number of New York Stock Exchange shares sold short had rocketed to a record 10.5 billion, from 9.6 billion in mid-February.
Some of those short-sellers can’t be too happy at the moment -- unless they shorted housing stocks. Los Angeles-based KB Home ended Friday at $42.67, down 17% for the quarter after plunging 29% last year. But the broader market has recovered most of what it lost in the recent pullback.
The S&P; 500 inched up 0.2% for the quarter. The Dow Jones industrial average eased 0.9%.
For the most part, the flight from risky assets ran its course quickly. Investors soon returned to many of those markets.
Mexico’s IPC stock index ended the quarter at an all-time high, and up 8.7% for the three months, despite losing 8% from Feb. 27 to March 5. If the U.S. economy is about to crumble, investors shouldn’t be buying Mexican stocks, given the links between the two economies.
Indexes of U.S. small and mid-size stocks handily beat blue-chip shares in the quarter. If investors really were afraid that a recession loomed, you’d expect them to favor the relative safety of bigger stocks over smaller issues.
Even the late-March jump in oil prices, fueled in part by the seizure of British naval personnel by Iran, failed to rattle global markets much. Crude oil ended Friday at $65.87 a barrel in New York, up from $61.05 at year’s end and near a six-month high.
There are, of course, plenty of people who are worried enough about the economy to keep their portfolios tilted to the conservative side.
One is Christopher Sheldon, investment strategist at Mellon Private Wealth Management in Boston.
He says the firm got rid of the last of its high-yield junk bonds in the quarter and pared back on emerging-market stocks, seeking to reduce risk.
“There is such a thing as a too-slow economy,” as opposed to a soft landing, Sheldon said.
A rally in gold in the quarter suggested that some people were looking for insurance against economic or other trouble. Gold futures rose 4.4% in the period, to $663 an ounce.
Nonetheless, in the stock market cautious investors were overruled in March by those who figured there was still no good reason to doubt the soft-landing scenario, even as housing slumps.
“I think the expected path of the economy hasn’t changed,” said Brian Stine, investment strategist at Allegiant Asset Management in Cleveland. “I’m fairly upbeat.”
Some economic reports Friday showed why the bulls remained optimistic. U.S. consumers’ spending and income rose more than expected in February, as did commercial construction spending.
And a Chicago-area index of manufacturing activity rose at a faster-than-expected pace in March.
“Incomes are holding up and unemployment is low. That’s really a pretty solid underpinning for the market,” said Michelle Clayman, chief investment officer at New Amsterdam Partners in New York.
Economic bulls also can point to gains in shares of industrial giants such as U.S. Steel, which surged nearly 36% in the quarter, to finish at $99.17. Healthy demand for steel overseas underpinned U.S. Steel’s advance and also boosts hope that economic strength abroad will help buttress the American economy.
There’s still the possibility, however, that February was the last gasp for the U.S. consumer, before housing-market fears deepened. That’s why Wall Street will be watching spring spending data carefully.
First-quarter corporate earnings reports due this month also will be key to markets’ next moves.
Earnings in the financial-service sector will be particularly scrutinized, for obvious reason: If more than just sub-prime mortgage borrowers are having difficulty paying what they owe to lenders, that should begin to show up in earnings reports of banks, brokerages and other financial-service firms.
Given the importance of financial-company earnings in the benchmark S&P; 500 index -- that sector accounts for 27.2% of the index’s profit, more than any other industry -- severe weakness in that business would be no small matter.
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No pattern
Global stock markets and industry sectors were all over the map in the first quarter in terms of performance.
First-quarter percentage changes in key stock indexes
Dow utilities ... +9.5%
Mexico (IPC) ... +8.7
S&P; mid-size ... +5.5
Germany (DAX) ... +4.8
Russell 2,000 ... +1.6
Japan (Nikkei) ... +0.4
Nasdaq comp. ... +0.3
S&P; 500 ... +0.2
NYSE financial ... -1.6
Nasdaq biotech ... -2.7
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Source: Bloomberg News
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Financial sector dominates S&P; 500
A profit slump at financial services companies could hammer overall earnings of the blue-chip Standard & Poor’s 500 index, because that sector dominates the index.
Earnings contribution to S&P; 500 earnings in 2006, by industry
Financial ... 27.2%
Energy ... 15.0
Technology ... 10.6
Healthcare ... 10.4
Industrials ... 10.3
Consumer big-ticket ... 8.6
Consumer staple goods ... 7.9
Basic materials ... 3.4
Utilities ... 3.3
Telecomm ... 3.2
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Total doesn’t add up to 100% because of rounding.
Source: Standard & Poor’s
