Major banks could emerge as stock market leaders again next year, if they can first establish new 12-month highs, according to a leading Wall Street technician. But higher interest rates and the prospects of a less favorable economy could stand in the way.
The top banks show signs of longer-range positive momentum, said Gail M. Dudack, chief equity strategist at Warburg Dillon Read in New York, particularly when viewed against their recent lows.
"But while there may be evidence of a new trend, we are talking about rates of change over 11 to 14 months," she cautioned. "These stocks would have to surpass their highs of 1998 and 1999 to provide confirmation of this trend - and there are some real challenges ahead."
Bank stocks are considered a good market indicator. Last spring, for instance, they fell before the Federal Reserve initially raised short-term interest rates on June 30, well ahead of other stocks.
The major bank group, which is designated by Standard & Poor's Corp., includes Bank of America Corp., Chase Manhattan Corp., and First Union Corp. It notably does not include Citigroup Inc., which is classified as a "financial-diversified" stock.
Undoubtedly, the biggest prospective hurdle for banks is higher interest rates.
Countering the banks' nascent positive trend, utilities' share prices, traditionally a leading indicator of trends in the bond market, have been plunging. Indeed, the Dow Jones utilities index hit a 12-month low last week.
An increasing number of economists say the Federal Reserve will continue raising short-term rates next year. Three increases this year have failed to curb the surging economy, which the central bank said is growing faster than its noninflationary sustainable trend rate.
"Bond yields will not peak until there are convincing signs of an economic slowdown and lessening credit demand," said Sung Won Sohn, chief economist at Wells Fargo & Co. But a slowdown requires a "sustained stock market correction," which is unlikely without further Fed action.
"At the moment, there are no convincing signs of an economic slowdown," he said. "The economy and the stock market have shrugged off the [Fed's] slow-motion monetary policy.
"However, the new year could be a different story. The Fed will ratchet up interest rates," he said. "Eventually, economic growth will decelerate."
Ms. Dudack said signs of a market correction are already appearing. She noted that all indicators in the "breadth/sentiment" section of Warburg's Technical Scoreboard of the market are either negative or "trending toward a sell signal."
Despite healthy trading volume in the market, she said, she views the current updraft in the market as a "bear market rally" that may soon be over. She noted that while the major market indexes - especially the technology-laden Nasdaq index - have been positive, "the broader market continued to deteriorate." As of Dec. 9, 70% of stocks on the New York Stock Exchange had lower prices than a year earlier.
Others see less risk in the outlook for rates and the market, and expect an economic "soft landing" next year, an ideal scenario for banks. "Our critical assumption is that the Fed won't slam on the brakes next year," said Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York.
Though bond yields will probably rise in anticipation of another Fed move, he noted that a 6.5% yield on the 30-year Treasury long bond would mean a real, inflation-adjusted rate of nearly 5%. That would be a record except for the early 1980s, when the central bank under chairman Paul A. Volcker aggressively raised rates to combat inflation.
"If bond yields are below current levels by this time next year, which we think likely, the equity market should do fine," Mr. Steinberg recently told clients.