Is the Rally Running Out of Steam?

By Josh Lipton In the near to intermediate term, market pros argue, it's a big green-light for investors. The stock market has rallied hard from the summertime lows on the back of friendly headlines, from QE2 to GOP victory to the tax extension. Strategists argue that this rally has more room to run. The news might remain unnerving in the months ahead -- with worries about everything from sovereign debt issues in Europe to policy tightening in China -- but those concerns will take a back seat as investors benefit from the powerful trifecta of low inflation, low interest rates, and an accommodative Federal Reserve.

(To read James Kostohryz's thoughts on out of control inflation in China, click here.)

Fed Head Ben Bernanke wants the stock market to move higher, believing that higher stock prices will boost consumer spending, profits, employment, and incomes. How we do we know this? He said so in the Washington Post on November 4 in an op-ed: Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

(To see Jeff Saut's article on how economic growth is beginning to materialize, click here.)

For these reasons, market pundits up and down the canyons of lower Manhattan whisper the following advice: now is the time to own risky assets. Respected strategists like Rich Bernstein remain optimistic as does Byron Wien, the vice chairman of Blackstone Advisory Services. He said this week that the S&P 500 could possibly even break out to new highs next year as corporate profits and the economy improve. Wien isn't alone in his optimism. Strategists surveyed by Bloomberg have a median estimate of $91 in earnings per share for S&P 500 companies next year, compared with the $84 projected for 2010. They see the S&P 500 rallying to 1,325 by the end of 2011, according to the median projection. Forecasts range from 1,200 to 1,550.

(To read Jeff Harding's thoughts on job growth, click here.)

Wall Street research departments sound just as cheerful. Goldman Sachs and Merrill Lynch both forecast the S&P 500 heading to a 1,400-1,450 range. The “500” right now is at 1,235. In the last three months, the SPDR S&P 500 ETF (SPY), which includes holdings like Exxon Mobil (XOM), Apple (AAPL), Microsoft (MSFT), IBM (IBM), and Bank of America (BAC), is up 11%. However, all this bullishness leaves some strategists feeling more cautious. These market pros argue that the optimism isn't warranted and that, in fact, this equity rally might be running out of steam. For support in their contrarian take, they point to sentiment and technicals, arguing that Mr Market is really now raising the yellow caution flag in the near to intermediate term. Gluskin Sheff's David Rosenberg, for one, notes that it seems the whole world is now bullish on equities. In part, that's why he says caution ahead appears warranted as, from a simplistic contrarian perspective, all that bullishness is bearish.

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