Wary Investors Give US Stocks Another Go

Recently, the stock market has been roaring, with the S&P 500 up a stunning 22% from October 3, 2011, which was the low of last year. In fact, the first month of 2012 has been one of the best Januaries on record for US stocks. On top of that, last Friday’s better-than-expected jobs report seems to provide further evidence that we’re turning a corner.

All this comes as a relief to the financial media, who had little to crow about in 2011. They are quickly making up for lost time. Many are highlighting the fact that major stock indexes are now approaching levels that will overcome all the losses that occurred since the financial crisis erupted in full view in September of 2008. Others are now claiming we’re really three years into a bull market, saying it began in March 2009 when US stocks finally hit bottom after losing more than half their value. 

However, there are many reasons to question the bestowal of bona-fide “bull” status on this market. It’s hard to miss the artificial props in place to push up prices. Everyday investors haven’t been blind to these, and are thus highly skeptical of the market. So, both the supply and demand sides of the equation are standing on shaky foundations.

Few investors have forgotten the carnage of 2008 and 2009, when a panic of epic proportions came about with little warning from the experts. Then, as now, most professional economists and analysts predicted clear sailing for months and years ahead. 

Even with the modestly better GDP and employment figures, there is now a much wider appreciation for the possibility of a financial meltdown than there was back in 2007. This is especially true given the unresolved problems in Europe and the possibility of debt contagion spreading across the West. These fears weigh down on equities, despite the continuing growth in corporate earnings. 

Then again, investors likely regard corporate earnings themselves with increased scrutiny. Given the current low-interest rate environment, many are justifiably suspicious of the longer-term sustainability of those earnings. Indeed, corporate revenues have been enhanced significantly by massive layoffs and lower product quality. Meanwhile, fearing political uncertainty surrounding taxation and regulations, corporations continue to accumulate cash. Some companies have taken advantage of low rates to lock-in long-term debt capital.  While these may be wise decisions, such moves do little to set the stage for future growth.

Last week, the ECB decided to fall in line with the Fed in its efforts to avoid recession. It is now more widely accepted that if recession continues to deepen in Europe, money will be created on a massive scale. It will be circulated covertly by the ECB’s distribution network of banks to bail out governments, the banking system itself, and, most likely, major EU corporations. 

It is also increasingly likely that problem countries within the eurozone will accept German ‘overseers’ to run their governments along more prudent lines. In Greece, the government finances, the economic budget, and the currency are now under the effective control of Germany.  

On the surface at least, these measures render the eurozone’s problems less acute. This has lent support to US stock markets. But the fiscal centralization and torrent of new euros will have a long-term cost.

Meanwhile, in January, the Fed announced that it would keep US interest rates at historic lows until at least the end of 2014. This prospect has added to the enthusiasm for risk. However, by continuing to deny the existence of inflation, despite growing visible evidence, Bernanke is building a gargantuan new bubble that can’t be ignored.

Although stock markets offer the possibility of upside gain and inflation protection, it is hard for investors to shake their fears of economic uncertainty. Many long for the day when stock markets can rise on their own accord without massive support from central bankers, and when the fears of overzealous government regulators do not dominate risk analysis. They want stocks, they just don’t trust these stocks. It is in their interest not to let the present euphoria overcome their justified caution.

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