Rally faces big test Wall Street just had its best third quarter in years and the Dow is at its all-time record. Could a selloff be looming in the week ahead? NEW YORK (CNNMoney.com) -- Was that it? The stock market just closed out the best third quarter in 9 years, defying expectations for equities to stall or more likely, slide. But the question for investors going into the fourth quarter - typically the best of the year - is whether the advance can continue. After a summer rally, the S&P 500 index stands just below a 5-1/2 year high and the Dow is just below its all-time high, not seen since Jan. 2000. The Nasdaq composite is up modestly year-to-date, but remains well below its record high. October tends to be a volatile month historically and with the major stock gauges hitting up against multi-year highs, next week could be particularly testy. "The economic data and earnings will ultimately determine whether we see our traditional fourth quarter rally or whether we've in fact moved it up into the third quarter," said Paul Mendelsohn, chief investment strategist at Windham Financial Services. The S&P 500 gained 5 percent in the third quarter, which ended Friday. That was the best third quarter performance for the broad index since 1997. What fueled it? Oil prices tumbled more than 20 percent after peaking in July above $78 a barrel. Geopolitical dangers seemed to cool. Bonds rallied, lowering yields and helping stocks. And the Federal Reserve paused - and possibly ended - its more than two-year old interest rate-hiking campaign. On one hand, Mendelsohn said, these factors and the momentum of the market could fuel further gains. But on the other hand, the market looks vulnerable to a selloff, after such a stellar quarter. On top of that, it's unclear just how much the economy is slowing, and "a slowing economy is equated to rising risks for stocks," said Alan Gayle, senior investment strategist at Trusco Capital Management. Last week, a report showed second-quarter gross domestic product growth slowed to a 2.6 percent annualized rate, missing economists' forecasts. Next year, growth is expected to sink to around a 2 percent rate from a projected 3.5 percent rate in 2006. Rough start to October? At the very least, stocks could be due for a little profit taking in the next week or two. "October is the time when investors decide if they believe what companies say about how the earnings are looking for the rest of the year," said John Forelli, portfolio manager at Independence Investments. That's because early October can bring a spate of quarterly earnings warnings about the just completed third quarter. It's also a time when companies tend to revise their full-year earnings forecasts and in some cases, the forecasts for 2007. Earnings tracker Thomson Financial is looking for the S&P 500 to post a thirteenth consecutive quarter of year-over-year earnings growth of at least 10 percent. However, some market watchers are worried that analysts' forecasts haven't fully incorporated how the economic slowdown will impact profits. Next week brings no market-moving earnings, but it should bring more pre-earnings announcements. In terms of next week's economic reports, Monday's ISM manufacturing index will be important, Mendelsohn said. Manufacturing has been a stalwart of the economy this year, after flagging in recent years. But lately, there have been some mixed signs on regional manufacturing that have raised concerns about how the sector is managing the economic slowdown. The recent Philadelphia Fed index showed a surprise contraction, while the NY Empire State index and the Chicago PMI both showed expansion in those parts of the country. Reports due later in the week include August factory orders and the September employment report, always a market mover. (see chart above for details) New worry: a hard 'soft landing' Wall Street gains from housing slump Winners in the third quarter: Apple (Charts), Electronic Arts (Charts) Losers in the third quarter: Yahoo (Charts), Halliburton (Charts) |
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