Economy puts stock rally to the test

Stocks may bob around the unchanged mark this week as investors wait for the US's economy to catch up to their lofty expectations after Wall Street's romp off its March lows.

"I think investors are saying we have come too far, too fast - and the stock market needs or should have a breather," said Hugh Johnson, chief investment officer at First Albany Corp.

The Standard & Poor's 500 index enjoyed a late-afternoon rally on Friday and is up about 25 per cent from its 2003 low hit on March 11. But the broad market measure has been traveling sideways in the past month.

Much of corporate America has posted quarterly profits that topped analysts' expectations, but Wall Street has been betting on a solid earnings performance for months now.

"Part of the run-up from March was in anticipation of better earnings reports - and that has happened," said Paul Cherney, chief market analyst of Standard & Poor's. "Right now the market is in a sideways consolidation mode."

Earnings reports will keep flooding Wall Street this week, but many investors are now turning their sights to the economy. A slew of key data on the job market, consumer confidence, manufacturing activity and gross domestic product will help investors decide just whether the market's monster rally was justified.

Better-than-expected results from corporate America in the second-quarter reporting period so far have helped support stocks, but they have not proved strong enough to budge the market much higher over the past few weeks.

Corporate scorecards will continue to rain down on Wall Street, including results from American Express Co., BMC Software Inc., Sprint Corp., Xerox Corp., McDonald's Corp., Tyco International Ltd., Verizon Communications, The Walt Disney Co., Exxon Mobil Corp., Halliburton Co. and Procter & Gamble Co.

Almost 65 per cent of the S&P 500 companies have posted quarterly earnings, according to Thomson First Call. Roughly 66 per cent of the companies have beaten Wall Street estimates, 22 per cent have met expectations and just 12 per cent have missed forecasts, the research firm said.

"The big question that faces investors and market participants is: 'What is left to inspire the buying, real buying, persistent buying?'" Mr Cherney said. "Unfortunately, I come up with a big question mark on that question, because we are coming into summer vacation when many desks are going to be empty."

Wall Street will also be hit with a wave of economic data. But analysts say that investors may not be too surprised on the upside after a sharp rise in optimism over past weeks.

Key economic reports include consumer confidence surveys, July non-farm payrolls, the Chicago Purchasing Management Index, a read on gross domestic product and the Institute for Supply Management's report on manufacturing.

Gross domestic product is estimated to have grown in the second quarter at an annual rate of 1.5 per cent, above a previous reading of 1.4 per cent. The GDP report is on Thursday's calendar. The Chicago Purchasing Management Index, also expected on Thursday, is forecast at 54.0 in July, up from 52.5 in June.

The July employment report, due on Friday, will contain the week's most closely watched numbers. Economists polled by Reuters expect non-farm payrolls to have added 18,000 jobs in July, following a loss of 30,000 jobs in June. The US unemployment rate is forecast at 6.3 per cent, down from 6.4 per cent in June.

Other forecasts worth noting in reports scheduled for Frida: The ISM manufacturing index is expected to rise to 51.8 in July from 49.8 in June; a reading of 50 or above indicates growth. The University of Michigan consumer sentiment survey's final reading for July is forecast at 90.5, up from 89.7.

Economic news will have to share some of the spotlight with government bonds. Prices of US Treasury bonds have plummeted, driving the yield on the benchmark 10-year note up to near a seven-month high, as growing confidence that the economy is poised to rebound in the year's second half year prompted investors to ditch bonds.

"We are seeing a pronounced weakness in the bond market for the last two weeks, and I think it's the very resounding cannon shot over the deck that things are about to change with respect to interest rates," said A.C. Moore, chief investment strategist at Dunvegan Associates.

Rising bond yields could stall economic growth by hiking borrowing costs, curbing the rebound that so many stock investors were betting on when they sent stocks up sharply this spring.