The stock market had sharp gains today on news that European leaders have finally agreed on a deal. However, there is a lot of concern that this uptrend is only a temporary things and the stock market will drop after this rally.
By: Patti Domm
Published: Thursday, 27 Oct 2011 | 2:31 PM ET
The stock market's sharp gains since early October came as investors let go of their worst fears, but it now needs to find a fresh catalyst to get back to its highs.
"In the context of the decline, yes, I think they're (these moves are) justified. Let's not forget the reason the stock market fell 20 percent was that the euro zone was breaking up and the U.S. was in a recession. We now know that neither of those things are true," said BTIG chief global strategist Dan Greenhaus.
Global stock markets and commodities rallied Thursday, after European leaders agreed to a deal to ramp up the firepower of their bailout fund—the European Financial Stability Facility — and extracted a deal from Greek debt holders to take a 50 percent loss on their holdings.
The euro rocketed above 1.41, a nearly 2 percent move, as investors who had shorted the single currency were forced to cover. U.S. stocks jumped more than 2.5 percent, while German and French stock markets saw gains of more than 5 percent.
Thursday's third quarter GDP report, the best in a year, also added fuel to the rally, as it strengthened the argument against a double dip recession for the U.S. economy.
Third quarter growth of 2.5 percent was as expected by economists, but some of the underlying components were stronger than expected. Personal consumption was one, gaining 2.4 percent, about a half percent better than forecast. Spending on services rose by 3 percent, the strongest gain since the second quarter of 2006. Business spending also helped, rising 17.4 percent in the quarter, the strongest rate in five quarters.
"The worst case scenario has been taken off the table for now, but we still haven't painted the optimistic picture. The optimistic picture is really how we take out the highs in the S&P, but I think there needs to be a catalyst for that," said Burt White, chief investment officer at LPL Financial.
"I don't think the bears have thrown in the towel yet. I still think there's a lot of things that can go wrong here. You still have a lot of pessimisn around the [European] plan. You still have a lot of pessimism around consumers. You still have a lot of pessimism around Washington. That keeps the fear balloon big, but I think we're going to get through it," White said.
The S&P 500, since bottoming at 1074 on Oct. 4, has bounced back by more than 16 percent, while the Dow is up more than around 14 percent in that time, crossing 12,000 Thursday for the first time since early August. The S&P's post-financial crisis high was 1363, set April 29.
"Admittedly, there are a significant number of headwinds. The Super Committee has the ability to put the market right back to 1100. I'm operating from a somewhat optimistic scenario for the immediate future, but my confidence around that forecast is quite low. The Super Committee could be an enormously destructive and unpredictable force," said Greenhaus.
The Congressional Super Committee, charged with finding $1.5 trillion in budget savings by Nov. 23, was formed after the contentious debt ceiling battle that led to Standard and Poor's downgrade of the U.S. credit rating during the summer. The uproar in Washington slammed business, consumer and investor confidence, and analysts are concerned the bipartisan committee could stir up some of the same type of acrimonious feelings as it comes down to the wire for a plan.
"The Super Committee is the next big buzz saw for me," said White. "..the concern is the $1.5 trillion in savings will not end up being $1.5 trillion, that it's all going to be smoke and mirrors" with the committee double counting cuts that were already expected, like the cost of the military engagement in Libya.
"If that's the case, I think you will have ratings agencies come out and say they are concerned, and we might not be split rated any longer. We might see Moody's [MCO 36.75] next or Fitch next," to cut the AAA rating, said White.
A positive for markets could also come from foreign central banks, if they begin to ease like Brazil has done, for instance, said James Paulsen, Wells Fargo [WFC 27.07] Capital Management chief investment strategist. But Paulsen is also concerned about what message Washington could send to the markets. "If Europe is on the shelf, we'll bring out the debt ceiling sequel. When you think about the sequels, they are never as interesting. I do mean that seriously. I don't think we're going to have near the financial fallout this time around," he said.
Earnings have been a mild positive for stocks, as most companies beat Wall Street estimates this quarter though there have been a few high profile disappointments, like Apple [AAPL 404.69] and Amazon.com [AMZN 206.78]. "Earnings have been okay. Guidance has been predictably lackluster," said Greenhaus.
Greenhaus also said he is concerned the consumer may not prove as strong in the fourth quarter, a concern for holiday retail sales. "It seems we have a little bit of a tail wind, which means recession in the fourth quarter is not going to happen. ...I think a problem for the fourth quarter is what got consumers spending in the third quarter is that consumers tapped their savings. Real incomes are very weak. It's hard to think that the consumer continues this pace of spending," he said.
But he does expect the S&P to get back to 1300 to 1325 this year.
White said if the market latches onto a catalyst, it could get to 1300 or better, and earnings could help. "I think we're going to, in a very volatile way, drift higher through the end of the year. I don't think 1370 on the S&P is going to be the high for the year. That said, we've come a long way quickly and we're probably in need here of a little bit of consolidation," White said. He said the near term hurdle for markets will be next week's economic data—the October employment report and ISM manufacturing data, as well as the Fed meeting midweek.
White said the market should continue its move higher unit mid November, when it focuses on the Super Committee but could resume its rise in December. "The technicals are beginning to look better. We just busted through the 150-day moving average  and the 200-day , which is the key one," he said. The S&P was holding above that level at midday.
Paulsen said he thinks the market may be going a little too far, too quickly but he still thinks its possible the S&P could hit 1400 by yearend. "I think we're at least going to go back and get to the old cycle highs...I still think there's a possibility for 1400, and that's going to depend if that data comes through on Main Street," he said.
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