x Abu Dhabi, UAEFriday 28 July 2017

Wall Street braces for post-January inertia just like past two years

Markets Update: The American stock market is no stranger to a strong January followed by months of grinding that goes nowhere.

The American stock market is no stranger to a strong January followed by months of grinding that goes nowhere.

That is what happened in 2011 and last year, and some analysts think 2013 could follow the same routine. Markets are up this year in the face of Washington's debates over fiscal policy, but a looming deadline on spending reductions could test the gains. "This is almost a carbon copy of last year," said Alan Lancz, the president of Alan B Lancz & Associates in Toledo, Ohio.

The mentality is "ride the wave as far as you can and try not to be the last one off," he said.

Major indexes recently crossed psychologically important milestones - 1,500 for the S&P 500 and 14,000 for the Dow industrials. The S&P is at its highest level in five years, while the Nasdaq finished on Friday at its highest close since November 2000, the tail end of the internet bubble.

The current levels are more significant than Wall Street's usual fixation on round numbers. This is only the second time the Dow has reached 14,000, and the third time the S&P has hit 1,500.

That could leave the market churning as investors test whether there is enough support to reach new highs, or if a pullback is needed. The sharp gains and overall bullishness on Wall Street leave stocks vulnerable to sudden shocks, such as a flare-up of the financial crisis in the euro zone, which sidetracked the market earlier last week.

One significant hurdle is the automatic federal spending cuts that will go into effect as of next month. So far, the equity market has largely ignored the back-and-forth related to delaying the so-called sequester that would trigger US$85 billion in automatic spending cuts, which would hit the defence industry particularly hard.

If the cuts go ahead unchanged, that could slow economic growth this year because of the swiftness of the cuts, according to the congressional budget office (CBO). While that's not as dire as the immediate threat of default presented by a possible failure to raise the debt ceiling, it isn't positive for markets.

"I don't see any grand compromise coming, largely because the markets are so complacent," said Greg Valliere, the chief political strategist at Potomac Research Group in Washington.

With the economic calendar light this week, investors could start to focus more on the political jockeying. The president Barack Obama's State of the Union address on Tuesday might also provide some insight into how the talks may shape up.

Mr Valliere put a 60 per cent chance on the sequester coming into effect next month while Washington scrambles to come up with a solution to alter it over the spring.

Markets may also be ignoring the political deal-making because the spending cuts would go towards reducing the high debt level of the United States. The CBO report, which included the cuts as they are, forecast the budget deficit will drop below $1 trillion a year after four years above that level.

But analysts worry about the broader implications of slower growth. "Across-the-board cuts will really be more damaging than strategic cuts," said Mr Lancz. "If we go into recession, all cards are off the table."

The economy already unexpectedly contracted in the fourth quarter of last year, but more recent data suggests subsequent revisions will show the economy did in fact grow, although at a weak pace.

The future path of monetary policy will be in focus this week as several members of the Federal Reserve are scheduled to speak on the economy and policy. The central bank is currently buying $858bn worth of assets a month as it tries to bolster the economy.

A growing number of policymakers say the Fed should taper its bond-buying when the time is right rather than bring the stimulus to an abrupt end and investors will be looking for signs of what the central bank's exit strategy may be.

The S&P 500 closed above 1,500 on Friday, though it is likely to face resistance rising above 1,523.57, which would be its highest intraday level since November 2007. Analysts say the index could ultimately make a run for the all-time high of 1,576.09.

Jeff Kleintop, the chief market strategist at LPL Financial in Boston, expects the market will experience a pullback in the 5 per cent range, although that should present a better buying opportunity.He suggests using the dips to buy stocks in sectors such as homebuilders and transport. "When you're in a trading range, you want to buy what's working."

For now, analysts are taking the market's sideways direction as a healthy move as it tries to establish a stronger base to push higher.

* Reuters