Can Stocks Break Out to the Upside?

12/01/2011 6:30 am EST

Focus: MARKETS

Michael Santoli

Senior Columnist, Yahoo! Finance

Michael Santoli, senior editor of Barron’s, discusses the backdrop of the stock market’s recent trading range, and what it may take for stocks to break out of this range.

In a recent piece that you did, you talked a lot about the trading range we’re in. It’s very frustrating for investors. Obviously a backdrop of "are we in a recession, are we not in a recession…"

It’s been kind of really narrow—if you look at a long-term chart—but it has felt very violent. You’ve had lots of 3% and 4% up-and-down days, and we’ve just been shuttling I think between these two emotional poles.

One of them is OK, the world is in peril, obviously we’re looking at everything coming out of Europe, and at the same time we’ve had to over the course of the late summer price in at least a heightened risk of a recession, a steeper slowdown in the economy domestically than we thought. Obviously, therefore, risk to corporate earnings.

I think at the bottom end of the range, all you have to really say or see in terms of news is that the world maybe is going to end much more slowly. All of a sudden, the buyers come in, and they say "Fine, we’ve got a reprieve, it’s not a pardon but it’s a reprieve."

I think right now it’s all about this relief that we can look at things like decent corporate earnings. We can look at the fact that the domestic economy probably grew more than 2% in the last quarter. In fact in July, we might have thought it was going to be zero.

I do feel like we’re feeling more comfortable up here, but from this point on I do think it’s probably going to take, not just less negative news, but something more constructive out there in terms of economic momentum.

Such as economic momentum?

I do think it’s economic momentum. I think that the strength that you’re seeing in certain pockets of the domestic economy, such as top-line retail sales, have been ok, they’ve been holding up pretty well. Midwest manufacturing has been this real stalwart out there, the auto companies and all the rest.

I think it kind of needs to broaden out from there to be more generally positive, just to get business confidence back and have people have something more self-sustaining.

Obviously Europe matters a lot, especially to the banking system here, so I don’t think we’re going to get much relief from that chasing every headline, believing every weekend is going to be the time when they have a meeting and actually are going to come away with a firm deal of some sort to backstab the banks. I do think that that’s what we’ll need to see.

At the bottom end of the range, I think there is enough value there in equities. Even corporate bonds in fact, corporate bonds kind of backed up along with everything else, and I think they improved the value there, which I had thought had been a little bit sketchy earlier in the year.

Do you see the economy growing enough to get us out of this trading range?

I don’t know that we can get the evidence soon enough that that’s the case, which is why I’m not expecting the market to kind of run away up without a lot of good news coming in.

Now I do think that the domestic economy is in somewhat better shape than the standard line. People are looking too much at things like consumer confidence, which I think is more just about long-term disgust with the fact that housing value have lagged, with the fact that people are sick of the current political situation, a lot of talk of the government debt and all the rest of it.

So I don’t think confidence matters. I do think business confidence…consumer confidence is less important than business confidence. I think there is a case to be made that we can just plug along at low-single-digit growth rates. Unfortunately, a little volatility in those growth rates…and still have corporate profitability be enough for the stock market to be OK.

To break out of the range on the upside.

Yes, I think we do have, as we get into next year there’s the chance of that. I’m very alert to the fact, though, that when you have these long trading range markets, you get these oscillations that can take us down into these little cyclical bear markets. Maybe we just had one down almost 20% or so, or maybe we’re kind of in the midst of one.

A lot of folks who look at the longer-term trend are saying it’s sending some alarm bells off. I do think we should put it on the bottom by decent corporate valuations. On the upside though, we run out of economic momentum, so that we can’t have those growth stories really dazzling us all the time.

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