Amid signs of a strengthening economy, stock investors have become more cautious in the face of a new landscape in which cheap credit may not be as abundant. Wall Street's main indexes were mixed the past week, as many investors appeared content to ride out the end of the year sitting on hefty gains from a nine-month rally.
The Dow Jones Industrial Average of blue chips slumped 1.36 percent in the week to Friday to end at 10,328.89 as the marketed headed into the holiday-shortened Christmas week. The index briefly moved above 10,500 for the first time since October 2008.
The technology-heavy Nasdaq composite however, rose 0.98 percent to 2,211.69 while the Standard & Poor's 500 broad-market index shed 0.36 percent to 1,102.47.
The broad market is sitting on a 22 percent gain for 2009 and is up some 60 percent from lows in early March. Investors are seeing increased signs that the US and global economies are rebounding, which is generally positive news. But this is also causing some market consternation because easy money may start to disappear.
The Federal Reserve on Wednesday maintained its federal funds base rate of a range of zero to 0.25 percent, but noted that with economic activity firming, it would wind down some emergency programs to keep credit flowing.
This suggested higher interest rates may come sooner rather than later, upsetting the environment helped by cheap credit.
"The economy continues to improve at a faster pace than expected," said Sung Won Sohn, economist at California State University.
Sohn said that even though Fed chairman Ben Bernanke has offered no timetable for rate hikes, they will come.
"Once chairman Bernanke and his colleagues embark on a path of higher interest rate, the increases won't be slow and gradual," Sohn said.
"Given the massive amount of excess liquidity in the economy, the Federal Reserve is likely to act faster than it had in the past."
This could upset the so-called carry trade that has been used to pump money into stocks, commodities and other risky assets using dollars borrowed at ultra-low rates. "As the Fed moves away from zero interest rates the dollar may rally as carry trades are unwound and this will reduce liquidity for equities and commodities markets," said Michael Malpede at Easy Forex.
Kent Engelke at Capitol Securities Management said the new economic landscape may dampen stock market enthusiasm, at least temporarily.
"I think equities could be in a period of rough sledding in the early part of 2010," he said. Engelke said corporate profits have risen as firms shed workers to boost productivity, but that new workers will be needed, hurting margins and productivity suffers.
Additionally, he said that with higher interest rates, "companies will need higher earnings to support valuation. If profits decline because of additional workers, so will prices."
But he argued that any weakness in the market will be short-lived "as such activity will convince all the recovery is indeed sustainable."
Analyst Craig Peckham at Jefferies said money managers are closing out their books for 2009, meaning the final two weeks may be uneventful. But he said that he views the churning market action of recent weeks as positive.
"I'd like to see the market consolidate in this pretty narrow range," he said. "This sets us up pretty well as we move into 2010 where I expect that we're going to see Investors putting capital back to work relatively quickly."
Bonds were mixed on the week. The yield on the 10-year Treasury bond rose to 3.546 percent from 3.540 percent a week earlier while that on the 30-year bond eased to 4.458 percent from 4.497. Bond yields and prices move in opposite directions.
The market will get a number of economic reports in the coming week, including a final revision on US economic growth for the third quarter, expected to be unchanged at 2.8 percent. Reports are also due on new and existing home sales and on personal income and spending.
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