The Six Unknowns That Are Roiling the Stock Market

After weeks of mad volatility, even long-time market observers are baffled by what's ahead for stocks. The general future is too uncertain.

The stock market's behavior is downright strange lately. Professionals with decades of market experience scratch their heads as the market falls to its lowest point of the year, then surges almost 7% in an afternoon—all for no apparent reason.

What's hanging over the stock market these days is uncertainty. In an environment where few know what's next, investors are skittish, corporate executives are cautious, and government officials are trying anything and everything to stabilize the situation.

BusinessWeek asked stock market experts to identify the biggest unknowns facing investors. These factors will be crucial to clearing up a foggy outlook. Unfortunately, it could take months—if not years—to resolve them.

1. Will the market lows hold?

On Nov. 13, the broad S&P 500 index and the tech-heavy Nasdaq composite dipped to their lowest points of the year. The Dow Jones industrial average got close, sliding below the key level of 8000. Then, however, buyers flooded the market and all three indices jumped more than 6%, mostly in the last 50 minutes of trading.

Randy Frederick, Charles Schwab's (SCHW) director of trading and derivatives, points out that this has happened roughly four times in the past two months: The market keeps returning to its lows, then rebounding. "It's actually an encouraging sign," he says. "The danger is if we dip below that."

Traders who rely on technical analysis—that is, watching the stock market's past patterns to predict future moves—could be unnerved by a significant drop below these levels. "That's when things will get spooky," he says.

2. What will President Obama do?

The victory of Barack Obama on Nov. 4 settled one unknown. Investors know who will be President on Jan. 20, 2009—they're just not sure what he's going to do.

"You have a new administration coming in, and nobody knows what the new rules are going to be," says James Reed, portfolio manager of the UMB Scout Fund (UMBSX). Hanging in the balance are efforts to stimulate the economy and end the credit crunch, taxes, health care policy, and new regulations for the financial industry.

"It will be interesting to see in the president's first 100 days how much of the changes he advocated can be implemented," says Richard Sparks of Schaeffer's Investment Research.

3. How bad will the layoffs be?

In October the U.S. unemployment rate rose from 6.1% to 6.5% and the consensus is that it will continue to climb. But how far and how fast?

Many companies have announced job cuts in the past month and the beginning of 2009 may be a crucial period. Firms are putting together budgets for next year, Reed says, and he's expecting "whopping layoffs in the first quarter."

The unemployment rate is "the key data point that everyone is watching," says Steve Neimeth, portfolio manager at AIG SunAmerica Asset Management. If the rate moves above 8%, consumers could slash their spending, and the economic recovery some hope to see in 2009 could be delayed, he says.

4. How happy will the holidays be?

Stressed out by the economic headlines, stock market losses, falling home values, and a precarious job market, consumers seem in no mood to spend during this holiday season. Nearly every retailer has lowered sales expectations.

"Expectations have been set very low," says Frederick. Holiday spending that beats the gloomy estimatescould boost retail stocks and the market as a whole.

However, sales figures could still disappoint. "The consumer is in retrench mode," says Ralph Shive, portfolio manager at 1st Source Funds. Falling energy prices have been likened to a 'tax cut.' But, Shive says, compared to the many factors stacked against the U.S. consumer, the "gas 'tax cut' won't be enough."

5. When will the hedge funds stop selling?

Market professionals speculate incessantly on the state of the hedge fund industry. But few have solid information as to what is going on.

Hedge funds invest billions of dollars in the market and often borrow to magnify that exposure. Reportedly, funds are being forced to sell assets because of their poor investment performance, the difficulty of obtaining credit, and most of all, because their investors are withdrawing money.

Funds don't want to disclose that they're being forced to sell assets, but many observers assume that hedge fund troubles are partly to blame for the market's big decline in past months. "None of this is out in public," Reed says. "It's all between the hedge funds and their customers."

Though hedge fund investors can pull their money out each month, the end of the year may cause even more investors to reduce fund exposure, Frederick warns.

6. What's the next turn in the credit crisis?

Every market expert has a different opinion on what the U.S. Treasury, the Federal Reserve, and regulators and central bankers around the world should be doing to resolve the global financial crisis. The biggest unknown may be whether—and when—they are ultimately successful.

"Credit drives the economy, and we are in a credit crunch of unknown degree," Shive says.

Some easing of credit-market conditions has cheered investors recently, Neimeth says. But, he adds, more could be done.

Many companies aren't able to obtain short-term financing because of problems in the commercial paper market. Neimeth says the government should protect investments in money market funds, a move that would add liquidity to the commercial paper market.

With so many unknowns continuing to make investors very uneasy, wild daily index swings are likely to keep our heads spinning.

Steverman is a reporter for BusinessWeek's Investing channel.