Stocks: A Painful New Phase

The stock market could give a nasty surprise to those investors who thought equities were already as low as they could go.

The broad Standard & Poor's 500-stock index fell below 800 on Feb. 17, dropping 4.6%, to 789.17. In the process, the market set off alarm bells on many Wall Street trading floors.

For the past few months, amid plenty of bad news, buyers have stepped in to prevent stocks from falling to their extreme lows of last November. Now technical strategists, who watch such things closely, say the markets have a downward momentum that could be tough to slow.

A close below 800 "would suggest a full test of the November lows is underway," warned Bruce Bittles, chief investment strategist at R.W. Baird.

Hope for a Rebound Fades

The level of 789 is particularly significant, says Uri Landesman of ING Investment Management (ING). "This is a very important battleground right here," he says.

It's not just technical traders who are worried. Long-term investors have been unnerved by a range of developments.

Just a few weeks ago, many portfolio managers spoke confidently of a second-half rebound for the U.S. economy. Those hopes may not have faded entirely, but few appear willing to bet money on them anymore.

"It continues to be a market that is rife with uncertainty," says Robert Siewert, a portfolio manager at Glenmede.

Brian Reynolds, chief market strategist at WJB Capital Group, says stock investors are catching onto the economic pessimism that already dominates credit markets. "There is another year of economic pain ahead," he says.

That pain is spreading fast. In fact, global developments are in many cases more alarming than those inside the U.S., says John Merrill of Tanglewood Wealth Management.

The economic output of Japan fell by 12.7% last quarter, according to data released Feb. 16. By contrast, advance data for the U.S. gross domestic product showed a 3.8% decline in the fourth quarter.

Market Balks at Stimulus, Bank Plan

To help stop the economy's slide, President Obama on Feb. 17 signed a $787 billion economic stimulus bill. Several days before, Treasury Secretary Timothy Geithner unveiled an effort to prop up the financial system.

Both fell flat with many investors. "The financial markets were not impressed with either the fiscal stimulus deal reached by Congress or the announcement of the financial rescue plan," says Deutsche Bank (DB) chief economist Joseph LaVorgna. The stimulus bill won't provide a significant boost until next year, he said, while Geithner's plan lacked details.

Markets were also rattled by parts of the stimulus bill that would limit bank executive pay, Landesman says.

"A lot of people are willing to believe good stuff is coming" from the Obama administration, Merrill says. "But there is some disappointment on what's come down so far."

Government, both in the U.S. and around the world, is a "powerful influence on equity markets," says Chad Deakins, portfolio manager of the RidgeWorth International Equity Fund (SCIIX). But investors get spooked when governments change laws and rewrite the rules.

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