Stock market likely to continue rebound this week

THIS week, the stock market will likely continue its rebound as the bulls retain the upper hand in arguments about recent weakness in earnings and economic data.

The bulls see all the causes of the weakness as passing problems: the weather, the emerging-markets scare, unrest in Ukraine and Venezuela. To the bulls, these issues will soon be forgotten, and the January sell-off will just be a stutter step in the market's steady march higher.

To the bears, weak data and periodic sell-offs in global stock and bond markets are cracks in the foundation of the rally that will not go away.

"Temporary or more fundamental? That's the question as US data likely weakens further and China's industrial data is negative," said economists at brokerage Nomura Securities, in a research report. "A string of weak data partly due to unseasonably cold weather suggest the economy has hit a 'soft patch' at the start of 2014."

The Dow Jones Industrial Average finished last week with a slight gain, bringing it within 3 per cent of breakeven for the year and within 4 per cent of its record high. The index is in the midst of what technical traders call "retesting" the peak.

Yet most of the recent data has been somewhere between confusing and dire: last week Walmart said it was having trouble getting people into its stores; a local reading of manufacturing activity in the Philadelphia area showed activity slowing; used-home sales plunged by 5 per cent in January.

From both China and the United States, the two engine rooms of the global economy, the messages are mixed. Chinese trade data earlier in February had shown surprising strength while US factory surveys were weak.

Perhaps the most threatening development for a rally built, in part, on the largesse of the Federal Reserve, was the return of an old nemesis in the minutes of the January central bank meeting. For the first mention time since the onset of the financial crisis in 2008, an unnamed Fed official tabled a discussion on the rate hike.

Traders are evidently betting that the weak data will deter the Fed from hastening its retreat from an expansionary policy, pointed out Lorenzo Di Mattia, manager of hedge fund Sibilla Global.

It "solved temporarily some of the biggest fears associated with a much-stronger economy", Mr Di Mattia said, in a note to clients. "These fears include the possible negative impact on housing from higher-yielding Treasuries, pressure on emerging market economies and currencies from higher rates, a potential sell-off in high yield debt and credit in general, and that the Federal Reserve might accelerate its pullback in bond purchases or raise rates earlier than expected."

Inflation data last week showed a slight up-tick in prices, hinting that this could be the year that Wall Street stops worrying about recessions and starts worrying about inflation.

"Inflation trends will play an important part in forecasting monetary policy," said economists at brokerage Nomura Securities, in a note to clients. "Moreover, as the labour market continues to improve, in a broader context, investors are becoming increasingly concerned about higher inflation in the future."

This week, new Fed chief Janet Yellen will face questions on her view of inflation and its effect on policy plans in her testimony before the Senate. Any hints that the longtime dove is becoming hawkish could scare the market.

On its current timetable, the Fed will have stopped cutting rates by means of bond purchases at the end of the year.

If the economic recovery follows the growth trajectory that bulls expect, the next logical step would be for the Fed to start raising rates to more "normal" levels in 2014.

Doing so would prevent the extraordinarily low cost of borrowing causing another bubble in credit markets or a spike in inflation.

This week's new-home sales report is likely to echo the used-home sales report that showed a 5 per cent plunge in sales from a month earlier, largely attributable to weather.

Still, in an outlook for 2014, Morgan Stanley economists concluded that the housing market has "room to run". Mortgage rates, supply-and-demand dynamics and historical trends suggest that the average home in a major US metropolitan area will rise in price by 5 per cent to 7 per cent this year, the economists said.

The winter is starting to feel like a permanent phenomenon. Weather maps for the Midwest and Northeast are once again awash in purple as yet another "cold blast" approaches. This is the kind of winter that grandparents describe to their grandchildren. If man-made climate change is a factor in its creation, as some meteorologists suspect, it may not be the last of its kind.

The weather has hurt all areas of the economy bar one. Energy futures and related shares have rallied in recent weeks, as oil prices bounced back above US$100 a barrel and natural-gas prices hit their highest levels since before the recession. Natural gas and heating oil are burned to heat homes and to produce electricity.

The spike in natural gas prices will likely pass with the winter weather, said analysts at brokerage Morgan Stanley. Bulls on the stock market are hoping that all the growth and inflation worries will fade in the spring, too.