Five Sparks for a Stock Market Comeback

What will keep equities on the upward path? BusinessWeek looks at the factors necessary for a sustainable rally

By David Bogoslaw

Even in the midst of the biggest drop in nonfarm payrolls in 34 years, (BusinessWeek.com, 12/5/08), major U.S. stock indexes rallied on Dec. 5 and extended their gains on Dec. 8. Though the November employment report was grim, investors appeared to be emboldened by President-elect Barack Obama's promise over the weekend to deliver the biggest government stimulus package seen in 50 years to get the economy moving again.

While stocks have had periodic up-moves in the past few months, efforts to foster a sustainable rally have come up short. The ever-present financial crisis ensures there's always a fresh batch of grim headlines to dash any hopes that stock prices are close to reaching a bottom. The lack of upward momentum is likely to persist now that the U.S. is mired in a recession that, according to a report released last week by the National Bureau of Economic Research, began a year ago and is projected to be the longest and deepest since 1982.

Still Some Hesitation

Since July 2007, five days is the longest winning streak the large-cap benchmark Standard & Poor's 500 index has been able to muster before succumbing to selling pressure and heading lower again. The market is well off the 11-year lows of Nov. 20, when the S&P 500 closed at 752.44, and investors seem ready to dive back into stocks. But maybe not totally ready. They're hesitating amid concerns about how long and deep the global recession will be, says Alec Young, equity strategist at Standard & Poor's Equity Research. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).) The consensus among economists is for the downturn to end in the middle of 2009, but most investors remain dubious.

"The market will usually look ahead six months. The reason rallies can't get any traction is there's still a lot of skepticism" about whether the timetable for a recovery will have to be extended, he says.

There's more than mere psychology at work here, even though to most casual observers of Wall Street the off-the-charts volatility defies logic, Young says. The trading is all a bet on when corporate earnings can be expected to improve. Investors' willingness to nibble at stocks at prices above the November lows suggests investors are ready to look to better days ahead.

In the meantime, though, danger lurks, especially with risks to the continued viability of the U.S. auto sector. Investors need coaxing to overcome worries about the possibility of 300,000 to 400,000 auto and auto-supply workers being laid off in the Midwest, says Young.

Against that backdrop, what could get the stock market back on an upward path? Here, BusinessWeek presents five key factors investment strategists say are needed to send equities off to the races again.

1. No More Downward Revisions to GDP Growth
For Alan Skrainka, chief investment strategist at Edward Jones & Co. in St. Louis, a key ingredient for investor confidence is a halt in the downward revisions to economic growth forecasts that the Federal Reserve Board and private economists have been issuing.

"If this quarter is truly the worst quarter and [productivity] will begin to improve sometime early next year, then the stock market may be close to a bottom," he says. "We can't continue to see lower and lower estimates for growth and we can't keep pushing out the time frame for recovery."