Intro

A SHOWER OF

uncertainty in April did little to clear up the investing picture for our pundits. While stocks survived a midmonth plunge to claw their way back near 13,000 on the Dow, our pundits generally agree the economy isn't so great. What they couldn't agree on was when and how it gets better.

Whether there is or isn't a recession, and whether it's a long one or a short one, remains up for debate among our market mavens. However, there's a growing consensus at least that a total meltdown isn't in the cards, thanks to aggressive March rates cuts and other actions by the Federal Reserve. As the experts watch, wait and wonder, concerns center on the health of the battered financial-services sector, the damage done to housing prices and that ability of American consumers to spend the economy back on the road to recovery once tax rebates hit their bank accounts.

"On one hand, the financial crisis is in many ways unprecedented, as is the housing bust," ISI Group's Ed Hyman wrote on April 7. "On the other hand, the policy responses are also in many ways unprecedented. That is not to say that the financial crisis is going to go away any time soon. And existing house prices are likely to continue to decline. But the policy responses are probably laying the foundation to prevent Armageddon."

With that rousing assessment in mind, Merrill Lynch's Richard Bernstein weighed in on the outlook for the beleaguered financial-services sector, which has written off billions of dollars in subprime mortgage loans and the related securities market.

"Depreciating assets, increasing regulation, government intervention, negative earnings surprises, equity offerings, and now a rally are great fodder for the media. Some investors, sensing undue fear, are trying to 'bottom fish.' That could be quite risky," he wrote on April 8. Bernstein called the sector a classic value trap of "stocks that appear to be undervalued but have no visible catalysts to keep them from becoming even more undervalued. Value investors typically underperform by buying stocks too early, and our strategists' work continues to strongly suggest that global financials fall into the 'value trap' category."

However, first-quarter earnings looked encouraging to J.P. Morgan strategist Thomas Lee, who called the initial crop of results a pleasant surprise, though one that occurs in the context of worst-case expectations.

"We realize skeptics will say that, 'sure, it is easy to beat estimates given the Street is looking for a decline of 15%,' but expectations (relative to fundamentals) are what matter more to stocks," he wrote in an April 16 note. At the time of writing, 93% of financial stocks beat diminished expectations, and the same improvements showed up in consumer staples and consumer discretionary stock, sectors that missed by a larger margin last quarter.

Liz Ann Sonders, chief investment strategist at Charles Schwab, saw the financial sector's performance as encouraging, due to its weight in the key S&P 500 stock index, "and perhaps more importantly, its influence on every area of the economy," she wrote April 11. "However, it's too early to tell if this is the start of a sustainable rise in both the financial sector and the overall market."

Tobias Levkovich, at Citigroup, doesn't think so. "We are more worried about the composition of earnings results for the second half of this year, possibly starting with the second-quarter earnings results," he said in an April 10 note. "Industrial production is likely to wane later this year because banks have tightened their credit standards markedly on commercial and industrial loans over the past nine months, and the benefits of the 2Q07 easy money are ending this quarter."

But other easy money may play a meaningful role on a retail level. Just as our pundits looked to the Fed to put the brakes on a meltdown, they're also looking to the government's wave of $600 to $1,200 tax rebates to add some pop to the consumer sector, despite recent plunges in the monthly and weekly measures of consumer confidence.

A spending spree may not happen as soon as the checks hit taxpayers' mailboxes, says Ed Yardeni, president of Yardeni Research.

"Many Americans go shopping when they are depressed. What about the surveys showing that they might save most of the checks that the Treasury is sending out now?" he wrote on April 30. "The same thing happened during Q3-2001. The following quarter they decided to spend it all after all. In other words, if they pay off their credit-card debts in May and June, they'll be primed to charge again in time for the back-to-school shopping season."

Sonders, in that same April 11 note, said the outlook for housing prices remains dismal, and that will weigh on short-term consumer decisions, and on investor behavior.

Uncertainty is the name of the game, and investors will have to lump it for now, writes Jeffrey Kleintop, chief strategist at LPL Financial.

"With encouraging signs of strength tempered by the steady rise in oil, we will continue to monitor conditions closely," he wrote April 28. "The rebates will help to offset the drags of housing and high oil prices on consumer spending. Also, the Fed rate cuts first enacted seven months ago will be kicking in to stimulate the real economy. We remain positive on the stock market and recommend above-average exposure to stocks; however, volatility is not likely to fade much."

The worst seems to have passed, but it's not clear the best is arriving any time soon.

Also See:

• Experts Ponder How Long Recession Will Last

• Don't Count Out the Stock Market

• Markets Limp Into 2008 Dogged by Recession Talk

Pundit Predictions

"For the time being, we continue to view financials as a classic value trap, and recommend that investors continue to underweight the sector. However, the sources of growth for tomorrow's financial companies are likely to differ from those of today. The challenge for the long-term investor is to identify the catalysts for that future growth. We think that the increased management and leverage of assets by non-U.S. households with strong balance sheets might provide significant long-term growth opportunities for the financial sector. Companies with significant expertise in these areas should have distinct competitive advantages in the years ahead." (Merrill Lynch Research, April 8)

Bill Gross, Pimco

Ed Hyman, ISI Group

"Judging by 2-year [Treasury bill] yields, which are 2.44% this morning, fears of an economic meltdown have receded. Moreover, the spread between 10-year bonds and fed funds hasn't widened this much since the last recovery." (ISI Group Research, April 10)

Jeffrey Kleintop, LPL Financial Services

"While lagging indicators continue to reflect weakness, leading indicators we are watching (sector leadership, credit spreads, and value of the dollar) provide encouraging signs that the strength in the stock market may continue. The rise in gasoline prices has fostered a big jump in inflation expectations among consumers, which has the potential to weigh on stock market valuations and threatens the sustainability of the rally. So far, 2008 has been typical for an election year the solid gains for stock market investors in election years typically come in the fourth quarter, after enduring wide swings around the point at which the year began." (LPL Weekly Market Commentary, April 28)

Thomas J. Lee, J.P. Morgan

"It is early in the quarter, but still indicative, and coming out better on the margin. Given 1Q included March, which was the worst possible environment in credit markets, we think 2Q could show a modest sequential improvement. Our baseline case calls for a short recession ending by midsummer, and with the credit crunch behind us, the focus of investors will shift to earnings (recession dynamics) and inflation." (J.P. Morgan Equity Research, April 16)

Tobias Levkovich, Citigroup

"Stick with early cyclical stocks that have already been punished. Earnings weakness for early cyclical sectors, such as financials and consumer discretionary, seem already to be factored into investor expectations. Yet, earnings forecasts for Industrials and Materials appear to be overly sanguine for the second half and into 2009; thus, we would avoid exposure to these areas before probable downward management guidance and negative earnings revisions in the next few months." (Citigroup Research, April 10)

Liz Ann Sonders, Charles Schwab

"We think the Fed's aggressive actions were a step in the right direction. But we believe risks to the economy and markets will remain high until the U.S. housing market stabilizes and that might require a substantial bailout by Congress. While global growth continues to support the U.S. economy somewhat, an economic slowdown abroad and there are signs of one pose additional risks. We recommend investors stick to their long-term asset allocation plan, and avoid the temptation to become overly aggressive or risk-averse in the face of heightened volatility, which we believe is likely to continue." (Charles Schwab Quarterly Market Summary, April 4)

Ed Yardeni, Yardeni Research

"It's showtime for the stock market. It has rallied impressively since the Fed's shock and awe show in March. It bottomed on March 10, before Bear Stearns imploded and was acquired by J.P. Morgan Chase. The S&P 500 is up 9.6% since then. So year to date, it is now down 4.9% vs. down 13.3% in mid-March. It is still 10.8% below its record closing peak of 1565.15 on October 9, 2007. Its 200-day moving average peaked at the end of last year and has been declining since then. It is now at 1430.83, only 2.4% from the S&P 500's close yesterday. If the selloff from mid-October through mid-March was just a correction in a bull market, then the S&P 500 should rise above its 200-day moving average, which then, with a lag, should turn up again. That's my scenario for the rest of the year, though it may take several more weeks for a decisive breakout." (Yardeni Research Morning Briefing, April 29)