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Markets & Stocks
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Bracing for a slowdown
The recovery may be settling into cruising speed. Will it mean the end of double-digit stock gains?
June 28, 2004: 7:22 AM EDT
By Mark Gongloff, CNN/Money senior writer

NEW YORK (CNN/Money) - If recent economic data are to be believed, then the speeding 18-wheeler of the U.S. economy is slowing down from 80 miles an hour to a cruising speed of about 65, and corporate profit growth will decelerate along with it.

If true, this might mean the end of double-digit gains for the major U.S. stock indices -- but it wouldn't mean money couldn't still be made in the market. Investors might just have to work a little harder for it.

On Friday, the government said economic growth in the first quarter was probably a good bit slower than it first estimated. Though gross domestic product (GDP) numbers are still subject to revision, the latest readings on the broadest measure of the economy showed a deceleration in two straight quarters. [For a run-down of this week's economic data and other key events, click here.]

That report, which included data showing slightly stronger inflation in the quarter than first anticipated, helped keep stock prices muddled at the end of an up-and-down week. The Dow Jones industrial average churned to a 0.4-percent loss on the week, the S&P 500 was virtually unchanged, and the Nasdaq jumped to a 2-percent gain. Talk about a lack of direction.

And more current data have also hinted at a cooling pace of growth. The leading index of the Economic Cycle Research Institute, a private research firm, fell this week to its lowest level in more than a year, continuing a steady downtrend in place since March. Meanwhile, orders for durable manufactured goods fell in April and May.

You could go broke betting against the durability of the American consumer's desire to spend money, but many economists still believe rising interest rates and other factors will keep growth in consumer spending, which makes up more than two-thirds of GDP, slower this year. The red-hot housing market, too, is expected to cool this year -- though it hasn't shown signs of doing so yet.

Make no mistake: very few analysts are predicting a recession. Far from it. What's possible, however, is that the economy, after flooring the accelerator following the beginning of the Iraq war last year, is now settling into a cruising speed, with a quite-healthy 4-percent rate of GDP growth possible for the rest of 2004.

"The recovery phase is probably behind us, and we've probably moved into a normalized expansion going forward," said John Derrick, director of research at U.S. Global Investors.

Meanwhile, though corporate earnings are still likely to be strong this year, they're coming off such a year of runaway gains in 2003 and early 2004, that the rate of year-over-year growth will almost certainly slow down in the second half.

Add to this the prospect for rising inflation, near-certain gains in interest rates and political uncertainty at home and abroad, and you could have the recipe for a quiet second half for the broader market.

Few analysts are expecting stocks to turn tail and run any time soon. But it does seem that the heady early days of the recent recovery, when stocks posted huge gains -- the Dow Jones industrial average jumped a whopping 43 percent between March 2003 and February 2004, for example -- are over.

"If interest rates stay locked in this range, above 4.5 percent on the 10-year Treasury note, and the Fed follows through on its telegraphed interest-rate hikes on the short end, that creates a headwind for stocks," said Charles Crane, chief market strategist for Victory SBSF Capital Management.

But Crane and other analysts believe money can still be made, if investors are willing to do a little leg work. Derrick of U.S. Global Investors suggested that some cyclical sectors, such as tech, industrials, basic materials and energy, could still enjoy gains in the early stages of rising rates.

Other money managers suggested boring down even deeper into the details, looking for specific companies with stronger-than-expected earnings and fairly cheap prices.

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"Price-to-earnings ratios are high by historic standards, but the bulls would say that, given low interest rates, they're not too expensive," said James Awad, chairman of Awad Asset Management. "I think they're generally not convincingly cheap or expensive -- the key is to find individual stocks that are cheap."

Other analysts believe investors' work could be easier than that.

They disagree that the acceleration in growth and earnings is over and think recent data, rather than a sell signal, are instead the first stages of another 1980s- or 1990s-style boom.

"We believe investors are too focused on the relative rate of change instead of respecting and admiring the absolute growth," said Brian Belski, managing director and market strategist at Piper Jaffray. "We believe the market will continue to grow at a double-digit percentage pace."

"We believe we're in a renewed growth cycle that could last three-to-five years," Belski added. "If you're waiting to jump in, you're going to miss the boat."

Big week

Unfortunately, this week probably won't do much to make the future more clear. Though it ought to be a rip-roaring week for news, and could help rouse the market from its slumber, much of the week's news could be priced in the market already.

Take that big Fed meeting in the middle of the week, for example. Markets stopped wondering long ago what would happen. They will pay close attention to the details of the Fed's harrumphing about its policy stance, but they've already baked an interest-rate hike in the cake.

Only a bigger-than-expected hike -- seemingly unlikely, given the shakiness of the recent economic data -- or no hike at all could make things interesting.

Then there's Iraq. The U.S.-led coalition handed the keys to the country over to an interim government Monday, two days ahead of schedule. But few expect the place to magically turn into Near East Epcot at that moment.

President Bush has promised that U.S. forces will remain in the country for as long as necessary, and the potential for violence against U.S. troops, members of the new government and oil facilities will likely remain for some time, too.

The biggest news, in fact, could come at the end of the week, with the Institute for Supply Management's (ISM) manufacturing index and the Labor Department's report on June unemployment and growth in non-farm payrolls. Much stronger-than-expected reports could raise fears of a quicker pace of Fed tightening. Weaker-than-expected reports could be another sign the economy's still tapping the brakes.

Key events in the week ahead:

  • Monday morning, the Commerce Department kicks off the week with its report on personal income and spending in May. Economists, on average, believe income rose 0.5 percent, following April's 0.6-percent gain, according to Briefing.com. Spending is expected to rise 0.8 percent after a 0.3-percent jump in April.
  • Tuesday morning, the Fed begins its two-day meeting to discuss monetary policy.
  • Later Tuesday morning, the Conference Board releases its closely-watched measure of consumer confidence. Economists believe its confidence index rose to 95 in June from 93.2 in May.
  • On Wednesday, the Coalition Provisional Authority in Iraq transfers sovereignty to an interim Iraqi government.
  • Wednesday morning, the National Association of Purchasing Management-Chicago releases its monthly index of Chicago-region business activity. Economists believe the index fell to 64.5 in June from 68 in May.
  • At about 2:15 p.m. ET on Wednesday, Fed policy makers will announce their target for the fed funds rate, an overnight bank lending rate that influences other rates in the economy. Economists, on average, expect the Fed to raise the fed funds rate to 1.25 percent, from 1 percent, the lowest level in more than 40 years.
  • Thursday morning, the Labor Department reports the number of new claims for unemployment benefits in the week ending June 26. Claims jumped to 349,000 in the prior week.
  • Later Thursday morning, The ISM releases its report on national manufacturing activity. Economists expect its index to slip to 61.2 in June from 62.8 in May.
  • Friday morning, the Labor Department releases its report on June unemployment and non-farm payroll growth. Economists expect the unemployment rate to hold steady at 5.6 percent and for payrolls to grow by 240,000, following May's 248,000-job gain.
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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.