A quick glance at the year-to-date performance of the Dow (+0.5%) and S&P 500 (-0.4%) camouflages what had been the worst-ever start to a year for stocks. But with Wall Street’s first-quarter winding down and headwinds still blowing at investors, the path forward for stocks after a strong rebound rally could be rocky. “The market will continue to be challenged by a lot of the same headwinds that have existed since the middle of last year,” says Michael Arone, chief investment strategist at State Street Global Advisors.
The list of headwinds that could slow stocks’ climb includes continued debate over the timing of the Federal Reserve’s next interest rate hike. At least one Fed official says the rise could come as early as April. Sluggish corporate profit growth will be another negative story line for stocks, as many U.S. companies continue to struggle to book sales and make money in a world dogged by slow economic growth. The fact that stock market valuations are currently pricier than long-term historical norms is also likely to give investors pause. Other sources of uncertainty include the unpredictable U.S. presidential election, the re-emergence of terrorism as front-page news, a still wobbly commodities complex and the possibility of the U.S. dollar gaining strength again and hurting sales of U.S. multinationals.
Yet another negative hanging over markets is growing concern that the world’s central banks are out of ammunition and will have difficulty boosting growth despite ongoing stimulus policies. “Given that backdrop, it will be difficult for stocks to climb considerably higher and hard to surpass the old record highs,” Arone says. Still, for the moment, investors are in a far better place than they were back in mid-February, when stocks looked like they were headed for their first bear market — or drop of 20% or more — since 2009. At the market’s closing low for the year on Feb. 11, year-to-date losses ranged from 10.1% for the blue chip Dow Jones industrial average to a more sizable 16% drop for the small-company Russell 2000 stock index. An ensuing rebound rally, however, has reduced the financial pain. The Dow is now in the black for the year, and the benchmark Standard & Poor’s 500 is almost back to even after the market surge trimmed its year-to-date loss to 0.4%.
More volatile stock indexes, such as the technology-packed Nasdaq, and the small-cap Russell 2000, remain more deeply in the red for the year, down about 5%. On the positive side of the ledger, the federal government on Friday upgraded U.S. economic growth for the fourth-quarter of 2015 to 1.4% from 1%. The move signals that the economy was entering the new year on a stronger footing and was not flashing signs of recession, Chris Rupkey, chief financial economist at MUFG Union Bank, wrote in a client report Friday. “Net, net, the economy, real economic growth was stronger than we thought late last year, and this makes us more hopeful that the first quarter will be better than expected and surprise us on the upside as well,” Rupkey wrote.