Stocks Fall on Economic Worries

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Rebutting talk that stocks are near a bottom, equity strategist Tobias Levkovich at Citi Investment Research in an email research note cited "likely performance pressures in areas that investors still seem eager to buy," and said it was too early to step up to the Capital Goods, Industrial Conglomerates, Energy and Materials sectors, barring unpredictable external factors such as a hurricane. Levkovich said his research team has found a six-month lag in stock price direction following the trend detected by the Economic Cycle Research Institute, whose weekly index continues to confirm stock price weakness.

Levkovich said he doesn't expect the strengthening dollar to have a meaningful negative impact on multinational companies' sales until the first half of 2009. He predicted the 9% tailwind in multinationals' sales that the dollar provided during the first half of 2008 will flatten out in the third quarter and be a slight drag in the fourth quarter before becoming a minor headwind of 2% to 4% in the first six months of next year, assuming no further greenback appreciation.

"A dramatic change in export trends will take longer to play out given that competitiveness and sourcing decisions are more complex and do not shift on the basis of short-term foreign exchange fluctuations," he wrote.

It's still difficult to call a bottom for the economy even though many of the risks to further economic slowing have already been priced into the market, says Ihab Salib, portfolio manager and head of international fixed income at Federated Investors in Pittsburgh. He sees Commerzbank's AG announcement that it will acquire Dresdner Bank AG from insurer Allianz SE in a two-part, stock-and-cash deal valued at $14.3 billion as a good sign. A cash-infusion deal for Lehman Brothers (SCRX) would be another indication that even if the market isn't putting in a bottom, "at least people are comfortable taking on those risks [with the confidence that] valuations are somewhere near reality," he says.

The only argument for equities now is there's a lot of money around that investors want to put to work, says Andres at Investnet. But given his view that there's more bad news for equities still to come, he sees the bond market being the benficiary of the stronger dollar, since "Europeans investors are better off owning two-year or other short-end Treasuries and benefitting if the dollar goes up [further]," than buying equities.

On the economic data front, the U.S. Institute for Supply Management index slipped to 49.9 in August from 50.0 in July, offering little clarity on the state of the U.S. economy in the third quarter.

Construction spending fell 0.6% in July, double the anticipated decline, and the first time spending has dropped in three months. Unlike in May and June, the continued sharp decline in residential investment was not offset in July by solid gains in nonresidential spending. Although this report is a lagging indicator, it suggests that the construction sector got off to a weak start at the start of the third quarter, John Ryding at RDQ Economics wrote in an email note.

The most watched numbers this week will be the Labor Dept.’s employment report for August, due out on Friday. Economists predict another moderate drop in payrolls of 70,000 workers, close to the 66,000 average monthly decline from January to July. They expect the unemployment rate to hold steady at July’s 5.7% reading. Those numbers, if realized, would imply the economy remains weak but would not suggest any additional deterioration.