Four Reasons the Markets Are Still Troubled

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Elaine Thompson / AP

Shoppers look over shoes near sale signs lined-up for the fall sale at REI, an outdoor retail store in Seattle

Message to Wall Street: Don't put away your worried faces just yet. Monday's 11% bounce on the Dow Jones industrial average was followed by a more solemn Tuesday, with the Dow sinking .8% as investors pulled back fearing tough times ahead. There's still a real economy out there — and it's still hurting. Shares in blue-chip companies fell yesterday as layoffs in places like PepsiCo loomed. In the days ahead, Wall Street will receive several reality checks that could take the fizz out of any good cheer brought on by the Dow's biggest one-day gain since 1933.

The data being released this week — including important third quarter company earnings reports, September retail sales and housing starts — will likely add up to a bleak picture, both in terms of consumer confidence levels and the overall health of the U.S. economy. "The data will show an economy that has lost a lot of steam in September in relation to August," says Joe LaVorgna, chief U.S. economist at Deutsche Bank. "It remains to be seen how bad October will be, but we could really see a bad quarter in terms of Gross Domestic Product performance where we are down at least a couple of percentage points."

Analysts and investment funds will be on the lookout for these potentially market-moving moments taking place this week:

Retail Sales: The most significant barometer of economic health came out today in the Census Bureau's retail sales report. As expected, the numbers weren't pretty. Retail sales in September dropped to $375.5 billion, a 1.2% decrease from August. With access to credit severely restricted by the banking crisis, this third consecutive month of shrinking sales is significant because it happened during the back-to-school shopping period, usually retailers' biggest month outside the December holiday season. And a three-month decline in sales like this — September's drop was the worst — hasn't occurred since the 1990-1991 recession.

Retail purchases fuel half of American consumer spending, which stimulates the country's economic growth. In the past, consumer spending has comprised as much as two-thirds of the gross national product. "Retail sales is the most important number because it doesn't gauge reactions, but gauges what consumers are doing and it's a good indicator of actual spending," says Michael Englund, chief economist for Action Economics, a bond and currency market consulting firm. "The good news for households is that food and energy prices are falling, although some might see this as a weakness in demand and a sign the economy is slowing." Englund says the drop below August's sales levels are mostly due to extremely weak auto sales, as people have had difficulty getting loans due to tighter credit and higher rates. "Our view is that the current downturn will equal or surpass the downturn of late 1990, early 1991," says LaVogna.

Consumer Sentiment: On Friday, the University of Michigan Survey of Consumers posts its sentiment index for early October, which measures shoppers' outlooks as they gear up for the holiday buying season, a crucial period that accounts for as much as 40% of retailers' annual sales. "Traditionally, if gas prices are up, consumer confidence is down," says Englund. "I'm not sure what will be captured by the Michigan Index, but I think it will drop because the RBC index dropped and that makes intuitive sense." According to the National Monthly RBC/CASH (Consumer Attitudes and Spending by Household) Index, consumer confidence plummeted 32 points in October, from 69.2 in September to 37.0 in October, the largest single monthly decline in sentiment since the Index began in 2002.

Housing Starts: Also on Friday, the U.S. Census Bureau releases housing starts, a figure that measures the number of privately-owned new residential homes being built. Analysts predict figures will either level off or continue to drift downward slightly from the August number of 895,000. The upside: "There isn't a lot of room for decline," says Englund. Many experts believe the bottom is near. LaVorgna says it is just a matter of time before the number drops below 800,000, a large plummet from the 2005 high of more than 2 million new homes under construction.

Corporate Earnings: The good news is that on Tuesday Johnson & Johnson, maker of such staples like Band Aid and Listerine, reported a 30% increase in its third-quarter profit, besting analysts' average estimates by 6 cents a share. The healthcare conglomerate earned $3.31 billion, up from $2.55 billion in the same period a year ago, attributing its higher earnings to increased sales of consumer goods and medical devices — at least Americans are still buying some products. But not all American consumer-product companies are doing so well. PepsiCo, maker of the popular soft drink, missed analyst estimates; shares are off by 8.9%. The company announced layoffs of 3,300 jobs or about 1.8% of the workforce.

Analysts also await Google's third quarter earnings announcement on Thursday as an indicator of how the technology company will be able to grapple with the tough economic climate. Ross Sandler, senior internet analyst at RBC Capital Markets, expects Google's revenue to be up 33.5% over the same time last year with a 3% growth rate from second to third quarter, even though its stock price recently sank to the lowest it has been in two years. "Google is down 25% in the last month or so, but ... there is nothing wrong with Google structurally," says Sandler. "Every company exposed to advertising is having problems because budgets in general are contracting and no one is immune." Still, the Mountain View, Calif., search giant is on everyone's mind. "If I am wrong and Google misses, it will magnify a weakening market," says Jason Avilio, analyst at Kaufman Brothers. "If it does better it will help the market, but I would expect the status quo."

(Click here for a photo gallery of market traders' faces.)