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 countries such as Ireland and Portugal.
“There is fear again in parts of Europe,” Mr. Landesman said. “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 1,300, or nearly 14% above current levels, he said.
Mr. Landesman cited merger activity, earnings 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 haven't participated in the stock market run-up with a number of cash-heavy larger companies will accelerate the pace of mergers-and-acquisitions 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 that their third-quarter earnings won't meet analysts' estimates, and 34 said that 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, Mr. Landesman said.
“There's no question that as the odds of Republicans taking over the House have increased, the market has been factoring that in,” he 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 will reduce fears of more “disastrous legislation such as health care and financial reform,” Mr. Landesman said.
“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.”
E-mail Jeff Benjamin at firstname.lastname@example.org.
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