economy's signs of life may spell doom for stocks

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    Economy's signs of life may spell doom for stocks
    By Adam Shell, USA TODAY
    NEW YORK — A sharp spike up in new jobs in April is good news for the economy. But it could translate into bad news for stock market investors.
    Faulty logic? Hardly. The reason 274,000 newly created jobs in one month could be deemed a negative is because signs of life in the economy temporarily put to rest talk of a "soft patch." That dashes hopes that the Federal Reserve will pause in its campaign to boost short-term interest rates to a "neutral" level.

    The S&P 500's performance 12 months after rates were raised a total of 2 percentage points:
    Aug. 9, 1929 -34.1%
    Oct. 16, 1931 -37.3%
    Aug. 23, 1957 6.8%
    Sept. 11, 1959 -3.6%
    June 11, 1973 -6.9%
    July 3, 1978 2.8%
    Nov. 17, 1980 -13.8%
    Feb. 1, 1995 40.5%
    Source: InvesTech Research

    Any investor who has studied financial history knows that stocks struggle when the Fed is boosting borrowing costs. There's a growing consensus that investors should get used to the malaise that has gripped Wall Street all year. That's because stocks aren't likely to snap out of their funk until there's a strong sign the Fed is close to done with its rate-raising campaign.

    Some strategists, including Robert W. Baird's Bruce Bittles, say that might not happen until later this year. "It's hard to fight the Fed for that long," he says.

    In fact, in the eight instances since 1929, when the Fed raised short-term rates by 2 percentage points — as they have in the current cycle — the Standard & Poor's 500 index was lower 12 months later five times, says InvesTech Research. Similarly, the last two times the Fed raised rates eight consecutive times, in the 1970s, the S&P was down an average 1.4% a year later.

    Many Wall Street pros expect the same in 2005. "The prospect of higher interest rates will continue to hang over the stock market like the sword of Damocles," says Michael Panzner of Rabo Securities USA. The Dow Jones industrials mustered only a five-point gain Friday, despite rising 1.5% for the week, due to increased fears that the Fed will continue to raise rates, says Susan Hering, a UBS economist.

    After Tuesday's quarter-point rate increase, the Fed's target for short-term interest rates is 3%, up from 1% in June 2004. But investors that bet on future Fed moves have priced in a 3.75% rate by year's end, and they say there's a 40% chance that rates could reach 4%, consulting firm says.

    If the economy continues to keep growing at a 3% clip or faster and the threat of rising inflation remains high, stock investors are also confronted with the prospect of rates on longer-term bonds, such as the 10-year Treasury note, heading higher. On Friday, the yield on the 10-year bond jumped to 4.27%, from 4.15% the day before.

    James Stack, president of InvesTech Research, says stocks may struggle even after the Fed is done raising rates. He notes that of the past 10 Fed interest-rate tightening cycles in the past 50 years, the Fed tightened too much and caused a recession eight times. "The Fed has orchestrated only two soft landings, and one ended in a bear market," he says.

    With the bull market now more than 31 months old — one month longer than the median bull market dating to 1928 — the prospect of even higher rates does not bode well for stocks, Stack adds.
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