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Halfway there
The first half has been a pleasant surprise for Wall Street. Let's see what the second brings.
July 1, 2003: 8:26 AM EDT
By Justin Lahart, CNN/Money Senior Writer

NEW YORK (CNN/Money) - It's not hard to find Wall Streeters who weren't particularly surprised by anything that happened in the first half of 2003.

The big rally in which stocks and bonds joined hands and sped skyward was no stunner, nor was the speed with which Saddam Hussein lost control of Iraq. The way the White House muscled through its big tax package didn't catch them off guard. Neither did the Fed's surprising shift in tactics at its May meeting. Sammy Sosa's corked bat, the ending of the new Harry Potter novel and moviegoers finding Nemo more appealing than Neo? All totally expected.

For those of us without such finely honed, er, forecasting abilities, however, the year has been a bit of a shock. Sure, some were lucky enough to gets bits and pieces of what was going to happen right, but the whole picture was downright elusive.

Despite the poor record, Wall Street is approaching the second half of the year with more than its usual sunny optimism. The big reason for the improved outlook? Part of it is due to the tax cut, which, Merrill Lynch estimates, is going to boost U.S. household income by $30 billion in the third quarter. But the big reason is the Fed, which signaled back in May that it doesn't plan on raising rates until well after the economy begins to improve.

"You have the Fed jumping up and down and saying 'We're not going to raise rates anytime soon, so have at it speculators,'" said Trilogy Advisors chief investment officer Bill Sterling. "They're making it very painful for the cash sitting in money market funds to stay sitting."

Indeed, cash in low-yielding money market funds has already begun to leave, seeking out better returns elsewhere, whether that means stocks, bonds or other investments. What it comes to is money's getting pulled out of the nation's mattress, where it isn't doing all that much, and going back to work in the economy.

"All of my business life, the Fed has played defense," said Aeltus Investment Management strategist Jim Griffin. "Now it's crossed the scrimmage line and started playing offense. It's brought us to rates so low that even multimillionaires can't live off the yield. The Fed wants you to buy bonds, buy stocks, start a business, hire some people, and it is going to continue to hammer at you until you do it."

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Even cautious sorts think the economy will be growing at a decent clip through the rest of the year. Merrill Lynch chief North American economist David Rosenberg, for instance, reckons the economy will grow at an annualized 3.5 percent rate in the third quarter and then grow at 2.75 percent in the fourth. That's not stellar, but compared with the meager growth that's prevailed since the fall, it sure doesn't seem bad.

Trilogy's Sterling believes growth could potentially be even better, coming in at up to 4 or 5 percent over the next four quarters. Given the cost cutting that has gone on at companies, along with the margin expansion that typically comes after a downturn, he thinks earnings would swell significantly.

That'd be good for the stock market, and it would be good for the economy as well, because when companies are more profitable, they are far less reticent about hiring workers and buying new equipment.

The downside? On the economic front the big worry is that better growth could be just a flash in the pan, and that once the effects of the tax cut and the money the Fed is sending sloshing into the economy wane, it will be back into the mire. The key will likely be employment: If the labor market continues to deteriorate, consumer spending could run into trouble.

For the stock market the problem is much simpler: Valuation. With the big run in share prices, the market's beginning to look rather expensive.

"I think the rally has a while to go yet, maybe another few weeks," said Bollinger Capital Management head John Bollinger. "Then it's going to be choked off primarily by a valuation problem that people will not be able to dodge. Buying IBM at 30 times earnings -- that's very hard to do for most investors."

Bollinger suspects the market will meander through the rest of the summer, have a typical fall selloff and then rally through the end of the year. In the end, stocks will finish 2003 below their highs of the year, but up from where they started. A pleasant change from what happened the three previous years.

Key events in the week ahead

  • Economists surveyed by expect the June Chicago Purchasing Managers' Index of manufacturing activity, due out Monday, to come in at 52, slightly below May's reading of 52.2. Any number above 50 signals expansion in Chicago-area manufacturing activity.
  • The Institute for Supply Management puts out the national Purchasing Managers' Index on Tuesday. Economists expect the key reading on the health of the nation's manufacturing economy to lift to 50.5 for June from May's 49.4.
  • Through the day Tuesday, automakers will release June car and truck sales figures. Forecasters expect sales picked up to an annualized 12.9 million vehicles.
  • The June jobs report is expected to show further deterioration in the labor market, with the unemployment rate moving to 6.2 percent from May's 6.1 percent and a further 5,000 jobs falling off the payrolls.
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