The housing market's ongoing slide is also complicating things. The continued decline in sales and prices is causing a downward spiral. As more people default on their mortgages and resort to foreclosure, it keeps the financial pressure on banks, which are already saddled with a mountain of bad debt tied to mortgages.
Banks have already tightened credit standards in response to this bad debt and their need to preserve capital to survive. That has made it more difficult for cash-strapped consumers to get access to much-needed loans.
For stocks to rally, oil prices must fall by $25 to $30 a barrel, the housing market must stabilize and the credit crisis must ease, Chalupnik says. An oil price decline of that magnitude isn't so far-fetched, despite tight supplies and the seemingly insatiable demand for energy from China and India. Richard Suttmeier of RightSideAdvisors.com predicts the crude "bubble" will burst and prices will fall to $75 a barrel once Congress cracks down on oil speculators.
The negative impacts on spending due to high energy costs are likely to add up to a massive hit to corporate profitability, the fuel that drives stock prices. Heading into the year, investors were expecting a sharp earnings rebound in the second half. But those expectations are fading.
Analysts have been ratcheting down profit estimates for the second half of 2008. Expected third-quarter profit growth for the S&P 500 is now 12.6%, down from 17.3% on April 1, says Thomson Reuters. Growth of 59.3% is still expected for the fourth quarter, but that's in comparison to a very weak fourth quarter of 2007.
"Estimates still need to be trimmed," says Tobias Levkovich, Citigroup's chief investment strategist.
Investors will be listening closely to what companies have to say about the outlook for the remainder of the year when they release second-quarter earnings reports in coming weeks. Package-delivery giant UPS last week warned of weaker business activity for the remainder of the year, citing rising oil costs. Second-quarter profit is expected to drop 11.5%, down from an expected gain of 4.7% on Jan 1.
Another risk to earnings is a slowdown in profit growth from abroad, which has been a main driver of profit the past 18 months, warns Joseph Quinlan, chief market strategist for Bank of America. He believes U.S. global earnings have peaked, citing faltering demand in Europe and a slowdown in emerging markets. "That key earnings prop is not as sturdy as it once was, and that is not yet fully recognized by investors," Quinlan warned.
James Stack, editor of InvesTech Research, calls this confluence of bad events a "perfect economic storm," which has caused the value of the stock market to decline more than $2 trillion this year.
Still, Stack points out that the Dow's current slump — which includes its worst June performance since the Great Depression — has been just nine months long, still six months shy of the median bear market (half are shorter, half are longer). But with stocks trading at 13.4 times their forward 12-month profit projections, according to Thomson Reuters, Stack doesn't yet see a severe multiyear bear market like the ones in 1973-74 or 1929-32.
Keep an eye on the S&P 500