Investors wonder if rally on markets can withstand economic headwinds

TORONTO - Stock markets could be looking for some direction this week following a muted response to blowout employment numbers on Friday, capping a week that saw New York's Dow Jones industrials register a string of record high closes.

The TSX ended the week with slight pop, up 0.48 per cent, weighed down by gold stocks but New York registered strong gains, with the Dow gaining 2.18 per cent.

This means the Dow has more than made up the losses stemming from the 2008 financial collapse, rising over 115 per cent from the lows of March 2009 that resulted from the financial collapse and subsequent recession.

However, the TSX is still a good 2,300 points away from the all-time high of 15,073 from the summer of 2008.

Several items added up to improve sentiment, including strong trade data from China, positive news on U.S. home prices, a U.S. services sector expanding stronger than thought and then a jobs report showing the creation of 236,000 jobs last month. Also, the U.S. jobless rate edged down 0.2 of a point to 7.7 per cent, the lowest level in four years.

In Canada, the economy churned out a surprisingly strong 50,700 new jobs in February, most of them full-time, in the private sector and in Ontario.

Adding it all up, the average retail investor could think there's nothing standing in the way of more gains, but that could be a mistake.

"I think a lot of the rally that we’ve seen in the last two months almost seems as a correct predictor of the (jobs) data", said Andrew Pyle, senior wealth advisor and portfolio manager at ScotiaMcLeod in Peterborough, Ont.

"In other words, we may have already seen the bulk of whatever market gains we were going to get from numbers like this, at least for the professional money from this market."

Pyle points out that the bulk of the recovery from the lows of March 9, 2008 have been "on the backs of what I would call professional money."

"Retail money, we know for a fact, mainly sat on the sidelines and has only started to come into the market in the last several weeks."

Pyle notes that the retail investor has been encouraged by recent economic data and U.S. indexes topping old highs.

The problem is that they’re probably getting into the market at the wrong time.

"There’s nothing to say the market is going to pull back and we’re going into a protracted period of correction," he said.

"But it is a market that is rich and a market that most professional investors would look at needing to blow some froth off the top in order to do some base building and ensure this rally can continue."

One major headwind identified by analysts is a major effect from the settlement that prevented the U.S. from going over the so-called fiscal cliff at the end of December.

Arising from the agreement brokered between Democrats and Republicans was a two percentage point rise in payroll taxes from 4.2 per cent to 6.2 per cent.

"Two per cent is going to be about $120 billion out of wage earners' pockets, and for someone typically making $35,000 a year that’s $700 of after-tax money — that is significant," said Robert Gorman, chief portfolio strategist at TD Waterhouse.

"And I just have to think that this is going to bleed into the consumer spending numbers, sales for the mass merchandisers and so on. We have had a great run here of late and I do think, in the short term, that we’re probably going to have a catalyst or two and this could be one of them that causes some sober second thought and some retracement of what we’ve seen this year."

Concern over the effect of the higher tax surfaced last week when the U.S. Federal Reserve reported that the U.S. economy racked up generally moderate or modest growth in January and February.

But it cautioned that many districts said consumers pulled back slightly elsewhere after seeing taxes rise and gas prices increase. Some also expressed concerns about federal spending cuts that started on March 1.

And early data on February retail sales showed Americans cut back on spending as they contended with the increase in payroll taxes.

Traders will be looking to the February U.S. government report on retail sales for further indications on how the tax is impacting consumers. Economists expect sales to have increased 0.5 per cent during the month.

The eurozone government debt crisis could also be on investor radar screens this week after Fitch Ratings Agency on Friday downgraded Italy’s credit rating to BBB-plus from A-minus. Fitch also warned of a further downgrade, citing the uncertainty created by February’s inconclusive elections.

Fitch said the failure to come up with a clear winner makes it "unlikely that a stable new government can be formed in the next few weeks,” thereby harming prospects of further reforms.