The S&P 500 could fall by as much as 8% over the next three weeks, followed by a 22% rally to close out the year, according to Uri Landesman, president of Platinum Partners LP, a $500 million hedge fund shop.
“I'm bearish over the next three weeks because I think the stock market right now is ahead of the economy,” he said, citing the recent re-emergence of financial instability in places like Ireland and Portugal.
“There is fear again in parts of Europe,” Mr. Landesman added. “And there also seems to be a disconnect between the low level of consumer confidence and the stock market in September, which suggests this has been an institution-led rally.”
Stocks will fall, Mr. Landesman said, until the impact of the corporate earnings season gives investors a reason to be bullish on stocks.
The final quarter of the year could see a rally driving the S&P 500 as high as 1300, or nearly 14% above current levels, he said.
Mr. Landesman cited merger activity, earnings season and the November elections as the three factors likely to trigger a year-end market rally.
The combination of smaller companies that are undervalued and have not participated in the stock market run-up with a number of cash-heavy larger companies, will accelerate the pace of mergers-and-acquisition activity, he said.
“There is going to be accelerating levels of M&A activity, which is always important in any market rally,” Mr. Landesman said. “There will be lots of deals and the deals will be broad-based, across multiple sectors.”
On the outlook for earnings from the third quarter, which ends Thursday, Mr. Landesman is optimistic despite some disappointing early results.
Of the S&P 500 companies that have already made pre-announcements, 77 said their third-quarter earnings will not meet analysts' estimates, and 34 said they will exceed estimates.
“I expect to see more positive surprises,” Mr. Landesman said. “And you have to remember that there are two parts to an earnings report; there's the past three months and there's the outlook for the next three months.”
The upcoming midterm elections will have the biggest impact if they don't produce the results that Wall Street is already anticipating, he said.
“There's no question that, as the odds of Republicans taking over the House have increased, the market has been factoring that in,” Mr. Landesman said. “It's very important that the Democrats do not retain control of Congress, because what Wall Street wants to see out of Washington is nothing.”
The typical Washington gridlock that comes from a more balanced Congress, Mr. Landesman said, will reduce fears of more “disastrous legislation like health care and financial reform.”
“The stock market is clearly not enamored with President [Barack] Obama and his socialist tendencies,” he said. “As far as the stock market is concerned right now, there's probably more downside to a Republican loss than there is upside to a Republican victory.”
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