With fears of double-dip fading, investors ready to act

After fretting about an anemic economy early this summer, investors just reaped the rewards of one of the strongest Septembers in the stock market and are continuing to buy stocks in anticipation of the Federal Reserve juicing growth again with low interest rates.

The Dow Jones industrial average is flirting with 11,000 points, continuing an upward trend that started last month, when the Standard & Poor's 500 index rose 9 percent.

Low interest rates, which the Fed is expected to influence through a process called "quantitative easing," are perceived as an aid to the stock market. They provide low costs to businesses, cheap money for consumers who can get loans and a reason to buy stocks rather than low-yielding bonds.

As investors see countries throughout the world taking measures to keep rates low, they are worrying less about a double-dip recession and positioning themselves for a caffeinated economy and stock market.

"The current issue, in our view, is that investors' portfolio construction needs to shift toward cyclicals," or stocks in industrial, retail or technology companies that climb with the economy, said JPMorgan strategist Thomas Lee in a note to clients Tuesday.

It's not just the low rates that have prompted Lee and others to position investors for a year-end rally. Lee noted that the fourth quarter tends to be the season for rallies, as large investors such as hedge funds try to make up for dreary periods earlier in the year. And he sees "continued healing" for consumers and less economic weakness than previously feared.

S&P strategist Sam Stovall added that since 1990, "the fourth quarter is historically the best quarter for sector performance, as all 10 sectors have recorded relatively strong price increases," from a low of 2.8 percent on average in utilities to a high of 5.4 to 6.7 percent for consumer discretionary stocks.

"We'll probably have a reversal," with stocks falling 5 to 10 percent as investors are disappointed by profits, he said.

During much of the last quarter, analysts were expected to lower corporate profit forecasts to match an economy growing at less than 2 percent, rather than the 3 percent that had been anticipated. But they didn't lower expectations, according to Thomson Reuters analyst John Butters.

And that will be tested the next few weeks. As companies report third-quarter profits, expected to grow 24 percent, Ablin said investors will discover earnings won't be able to continue to grow at a similar clip over the next four quarters because the economy remains weak.

So he is telling clients not to add stocks now, but rather to wait for declines in earnings season and buy then.

Merrill Lynch analyst Steven DeSanctis warns investors to be particularly cautious about stocks of small and midsize companies.

Small companies are vulnerable because they tend to do their business in the United States, where the economy is expected to grow more slowly than in developing areas of the world, he said.

Investors, conscious of that weakness in the United States, did favor faster-growing emerging-market stocks last quarter. Citigroup analyst Geoffrey Dennis noted that they climbed 17.2 percent, nearly double the S&P 500's advance.

"We believe the ongoing appetite for emerging markets should help fuel a strong fourth quarter as well," said Dennis.

Citigroup economist Robert DiClemente, in a similar vein, attributes the recent gains to the expectation of continuing low rates and congressional changes friendly to growth, not the tiny improvement in the state of the consumer, with spending rising 0.4 percent and income up 0.6 percent in August.