Tough times dim Wall Street's honeymoon with Obama

By Herbert Lash
NEW YORK (Reuters) - Wall Street's honeymoon with President-elect Barack Obama appears to be under strain just five trading days into the New Year and putting a damper on the outlook for stocks in 2009.

After plunging to an 11-year low in November, stocks have rallied about 20 percent on enthusiasm over Obama's picks for his economic team, and hopes his planned stimulus package would end the U.S. recession by the second half of this year.

But a gloomy private sector jobs report, dire warnings from corporate America, Federal Reserve worries about deflation and a bleak U.S. budget outlook this week rekindled investor fears that the recession will be far more severe than expected.

"I think we're torn between optimism (about) the new administration and stimulus plans and the awful economic outlook," said Frank Lesh, a futures analyst and broker at FuturePath Trading LLC in Chicago.

The Dow fell but most stocks rose on Thursday as Obama sought to rally support for a massive fiscal stimulus package by warning that without bold action the U.S. recession -- already looming as the worst since World War II -- could drag on for years.

Aides have previously said they are discussing $775 billion in stimulus but Obama did not give a dollar figure in a speech on the economy at George Mason University in Washington.

The speech offered scant details about the stimulus plan and failed to meet Wall Street's expectations.

The first five trading days of January are often an early sign of how the year will end, according to the Stock Trader's Almanac.

The benchmark Standard & Poor's 500 Index .SPX -- the most widely watched index among institutional investors -- closed up 0.34 percent at 909.73 on Thursday, and is up 0.72 percent for the year.

Since the collapse of investment bank Lehman Brothers in September sent markets into freefall, stock buyers have lacked conviction in the rally's sustainability.

Many Americans are unable to tap any form of credit, fear they will be laid off from their jobs and are hunkering down, paying off debt.

U.S. gross domestic product is expected to shrink for four straight quarters ending June 30, 2009, the longest period of contraction on records dating back to 1947.

When data on last year's fourth quarter is released, the U.S. economy will likely have contracted more than 5 percent, if not more, raising a red flag for many investors. It will be the biggest drop since a 6.4 contraction in the first quarter of 1982.

"The biggest risk that we're seeing today is the potential for deflation," said Enrique Chang, chief investment officer at Kansas City, Missouri-based American Century Investments.

"There's nothing good about an environment where you have deflation. It's probably worse than when you have too much inflation."
Chang said that Obama, who will be sworn in January 20, and the new administration will do everything they can to avert deflation, a decline in prices that can lead to lower economic activity and the erosion of asset values.

"This forced level of savings at this particular time in the economy is very dangerous. So to me that doesn't bode well for any asset class. Our view on equities is cautious, our view on bonds is cautious," Chang said.

Others see a rebound in stocks by year's end.

Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, said periods of financial demise are more often followed by spectacular investment opportunities than examples of persistent, ongoing economic ruin.

Stocks have already priced in the bleak economic data, he said.

"It would really take amazingly terrible data to get the stock market much lower," Paulsen told Reuters on Wednesday.

The size of Obama's fiscal stimulus, along with cheaper stock valuations, lower oil prices and lots of cash seeking new investment point to a stock rally this year, said Bob Doll, vice chairman and chief investment officer of global equities at asset manager BlackRock Inc (BLK.N).

"We believe an earnings rebound is likely in 2010, the signs of which will become evident in 2009," Doll said in notes released on Wednesday with his 2009 forecast.

"Under this scenario, we believe a year-end S&P target of 1,000 to 1,050 would be reasonable," he said.

Stocks surged in December on relief the global financial system did not slide into the abyss after Lehman Brothers' failure in September, said David Joy, chief markets strategist at RiverSource Investments in Minneapolis.

Having overcome that concern, investors are now nervous about the consumer sector, he said.

"Once again people are focused on the real-time current economic strength, and the numbers are terrible," Joy said.

But he said the fiscal stimulus being thrown at the U.S. economy, especially since infrastructure spending will be "shovel-ready" and not go through banks, will spur growth in the second half of 2009.

Any signs that employment and house prices are rising will turn around consumer sentiment and point to recovery, Joy said.

Until then, RiverSource is biding its time and buying beaten-down securities, he said.

"We're more than happy to buy assets that are cheap and wait to be rewarded down the road when all this begins to dissipate," Joy said.

Source : Reuters.com