As one of the most dizzying bear market rallies in Wall Street history enters its second month, a nagging question faces investors: Is the stock market making real progress, or merely glossing over deeper problems in the U.S. economy that will trigger a new wave of losses?
Stocks surged more than 3 percent Thursday as Wells Fargo, one of the nation’s largest consumer banks, predicted record profits. The announcement kindled hopes that the financial system, which dragged the larger economy toward the brink, was now poised to lead the way out.
The Dow Jones industrial average gained 246 points and the broader Standard & Poor’s 500-stock index rose nearly 4 percent. The S&P 500 has now risen more than 25 percent since stocks bottomed out on March 9, one of its best runs since the Great Depression.
Signs have been accumulating that the economy, while a long way from recovery, may be bottoming. Credit markets, frozen at the height of the financial crisis, have thawed as the government shores up the financial system. Some of the worst-hit housing markets are edging toward a turnaround as low interest rates reel in buyers.
On Thursday, Lawrence Summers ’75, one of President Barack Obama’s top economic advisers, declared that the “free fall” in the economy was likely to end in the next few months.
But as investors abandon caution to snap up cheap bank stocks and riskier instruments, like junk bonds, to profit from the market’s earlier declines, skeptics are warning that the economy may face another leg down. Companies continue to shed jobs and consumers are hunkering down in anticipation of a halting recovery.
Most of America’s retailers on Thursday signaled that they expected to see a continued steep decline in sales as they waited for consumers to come out of hiding.
“I think this is all setting us up for a new low,” said Thomas J. Lee, the chief U.S. equity analyst at JPMorgan Chase, who predicted an 8 to 10 percent drop in stocks. “It’s not like I’m praying for it to happen, but it’s pretty much expected.”
Members of the Obama administration, once criticized for darkening the sense of economic gloom, have pointed out wisps of stability in corners of the economy as they try to build confidence in their agenda. But Summers also acknowledged that it was unclear how strong and rapid any turnaround would be.
Indeed, one of the biggest worries facing economists is what would happen if unemployment rose beyond expectations and unleashed another wave of spending contractions and lower corporate profits.
Even as major banks like Wells Fargo, Citigroup and Bank of America regain some profitability after devastating losses — buoyed in part by government efforts to breathe new life into the housing market — experts warn that companies reflecting other sectors of the economy will soon suffer a wave of sharper declines in earnings.
“There’s a migration of weakness,” said Nicholas Bohnsack, sector strategist at Strategas Research Partners. “What you’re now seeing is the nonfinancial segment really start to tail off.”