By Aaron Task
After a third quarter of wild swings and a big rally in October, the stock market heads into the home stretch virtually unchanged for 2011. After Monday's decline, the S&P 500 is down 0.5% year—to-date.
Four key issues hold the key to whether 2011 ends up being the first down year since 2008 or whether the Santa Claus rally comes to town, according to Greg Zuckerman of The Wall Street Journal:
The Core of Europe: Now that Europe's debt crisis has moved from the "periphery", markets will take their cues from interest rates in Italy and France. On Monday, for example, Italy sold $4.1 billion of 5-year debt at the highest yields since 1997, which pretty much set the tone for financial markets worldwide. (Update: On Tuesday again, Italian debt yields set the tone for global trading; after the Italian 10-year yield breached 7%, a critical threshold, European stocks fell sharply and the accompanying weakness in the euro led to early losses in U.S. trading.)
It's the Economy, Stupid: A big reason for the big rally in October was better-than-expected U.S. economic data. Many money managers were braced for an imminent "double-dip" and the positive surprises on GDP, employment, retail sales and other metrics helped account for the S&P's nearly 11% rise last month. Whether the economy continues to surprise on the upside, or slides back into the doldrums will go a long way in determining the market's next big move. (Update: Better-than-expected reports on U.S. retail sales, PPI and the Empire State Manufacturing Index helped offset the negative impact of rising Italian debt yields Tuesday morning and major averages pared their early losses.)
Junk in the Trunk: "The U.S. lending market needs to revive if growth is to rebound," Zuckerman writes. "To get an indication of the strength of lending markets, look to the junk-bond market" for cues on the ability of "lower-rated and riskier" companies to access the debt market.
China's Landing: Whether China's economy has a 'hard' or 'soft' landing is the critical question on many investors' minds. As the world's second-largest economy and a major importer of myriad commodities, the outcome will have a major impact on financial markets worldwide. "It's not yet clear if [Chinese leaders] will be able to slow things to a more manageable and healthy pace, or if a painful crash is inevitable," Zuckerman observers.
In the accompanying video, Zuckerman and I discuss these market forces as well as a fifth factor, which is less easy to quantify but potentially most important of all: Performance anxiety.
As of Oct. 30, the average hedge fund was down nearly 3% for the year and underperforming the S&P 500, according to Hennessee Group. Some noted hedge fund stars, like John Paulson, are faring far worse than the average (and the index), a sign of how even the "smartest" of smart money is struggling to make sense of (and profits in) an increasingly volatile market.
Considering the fees being charged by hedge funds and the "reputational risk" of lagging mutual funds, Zuckerman notes underperforming money managers may be tempted to "chase" the market if it exhibits any signs of strength.
As a result, Zuckerman's conclusion is that investors should "not get too bearish" before year-end, even if there are plenty of things to worry about these days.