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Rally faces first big test

Falling oil and relief about the Fed boosted stocks last month. The new week brings a new test of nerve.

By Alexandra Twin, CNNMoney.com senior writer
September 2 2006: 8:35 PM EDT


NEW YORK (CNNMoney.com) -- An unusually strong summer rally faces its first big test next week, when Wall Streeters return en masse, suntanned and perhaps ready to reconsider their portfolios.

Stocks defied historical trends and managed impressive gains in August, with the Dow ending last week just short of a 6-1/2 year high hit in May.

The Nasdaq composite jumped 4.5 percent in August, while the Dow added 1.8 percent and the S&P 500 index added 2.2 percent.

The gains on falling oil and gas prices and relief that the Federal Reserve finally took a break from its 2-year-old interest-rate hiking campaign. There were also signs that the economy seems to be slowing, but not heading into recession.

But the rally came in light summer trading, with many investors on the beach or in the mountains, or at least in wait-and-see mode regarding their portfolios.

Next week, Wall Street gets a little busier.

"Active managers are returning from vacation, and you'll see more money coming into the market," said Timothy Ghriskey, chief investment officer at Solaris Asset Management.

"I think the momentum can stay positive at least in the early part of the month," he said, citing lower oil prices and the belief that the Fed won't raise rates again at its next policy meeting Sept. 20.

But later in the month the market could be vulnerable, Ghriskey said, partly due to the recent rally and seasonal factors that make September and October typically tough for stocks.

In addition, the tone could become a lot more negative at that point, as stock investors begin to get more defensive and react to the slowdown in the economy, said Paul H. Levine, president at money manager Lifetime Financial Strategies.

"I think the bond market is showing us that the economic reality is pretty bad," Levine said. He was referring to the fact that short-term interest rates are higher than long-term rates, a so-called inverted yield curve, which tends to suggest an economic slowdown, or even a recession, is on the way.

But in the short term, the stock market could advance a bit more, he added, as the start of a new month tends to bring new money into the market.

Little news is good news?

Last week brought a slew of economic news - including reports showing higher personal income and spending, but only moderate consumer inflation. A separate report Friday showed modest job growth in August that was not inflationary.

The week ahead is pretty light on news, with the Fed's beige book and the revised read on second-quarter productivity the biggest reports on tap. And that absence of news may be a good thing for investors, provided the price of oil doesn't rear up too much.

"The rally (in August) was about the Fed and also about the drop in energy," said Barry Hyman, equity strategist at EKN Financial Services. With crude oil hovering just below $70 a barrel, an issue for next week's market might be whether energy prices stall or move higher, he noted.

No market-moving earnings are on tap next week, and it's too soon for a broad swath of companies to begin providing previews of the third quarter.

In terms of economic news, Wednesday's read on second-quarter productivity could be interesting. It's expected to show an upward revision overall, and downward pressure on unit labor costs, a good thing for inflation-sensitive investors.

Wednesday also brings the Fed's beige book read on the economy. The periodic survey of the central bank's 12 districts will be eyeballed at the next Fed policy meeting, making it relevant. Nonetheless, it is unlikely to answer broader questions about the economy and may not be a big market mover.

With the fundamentals and the news flow expected to stay positive, the other risk next week - besides a big rebound in oil - could be the stock market becoming a victim of its own recent, summer success.

Hyman said that after such a strong end to summer, the market could be due for a bit of a pullback, particularly with more traders returning to their desks next week.

Key events on tap

The read on second-quarter productivity, due Wednesday, is expected to be revised up to a 1.6 percent annual rate from an earlier read of 1.1 percent.
Also on Wednesday, the Institute for Supply Management releases its ISM services index, expected to rise to 55.0 in August from 54.8 in July.
July wholesale inventories, due Thursday, are expected to have risen 0.7 percent in the month, from 0.8 percent in June.