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Heed danger signs before you let exuberance rule
By Rachel Beck |
November 19, 2009, Thursday
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Print Edition
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SOMEBODY on a bus asks a friend, "How about that stock market?" The response: "Unbelievable."
Caribbean vacationers lounging poolside check their Blackberries for stock prices. Suburban gym members chat about the latest market gains during their morning workouts.
Welcome to the 2009 bull market -- or so many people think. They're buying up shares of everything from Google Inc to Bank of America Corp at a pace not seen since the 1930s. Since March, the Dow Jones industrial average has jumped 57 percent and the Standard & Poor's 500 index has gained 62 percent.
Investors are betting on a strong economic recovery. But here's the problem: Good news ahead could be bad news for the bull.
To understand why, consider the very thing that has boosted the market. The US government has spent nearly US$1 trillion to stimulate the economy and the Federal Reserve has maintained a policy of keeping interest rates near zero.
Those will disappear as the economy's health improves, potentially halting the bull market by taking away what has been its crutch -- sources of cheap and plentiful money. "Pretty soon the easy money phase could be behind us," said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors, an investment firm in Albany, New York.
The government has plunged big money into the marketplace, through tax cuts, construction projects and other measures. At the same time, low interest rates have invigorated stocks by reducing borrowing costs and bolstering corporate profits.
The low rates have also knocked down the returns of other short-term investments, like government bonds and money-market funds. Since people aren't getting high returns on those investments, they're buying stocks.
"The Fed is forcing everyone to take risk by buying stocks because if you don't take risk, you will be earning nothing on your money," said Ed Yardeni, president and chief investment strategist at Yardeni Research.
Yardeni said his clients, which include pension funds and institutional investors, feel like they don't have a choice but to buy stocks right now. He sees lots of "fully invested bears" -- investors who don't believe that investing in stocks makes sense right now because of the state of the economy, but they are buying anyway because they worry they might miss out on a bull run.
A strong economy is just what Yardeni and some others on Wall Street say could thwart the rally should it lead to higher interest rates and waning government stimulus.
The Fed isn't expected to act soon. The US central bank has kept the target range for its bank lending rate at zero to 0.25 percent since December. It pledged this month to keep that rate at a record low for an "extended period." How long that really means is anyone's guess.
In the past, higher rates didn't knock down stocks immediately. Back in 1982, a sustained bull market began amid a deep recession, and the gains lasted even though the Fed began to boost rates.
There was more to lure investors back to stocks then. Stock dividend yields were 6 percent then; today they are below 2 percent.
Investors still should heed the potential danger signs of today's market, before their exuberance gets the better of them.
Caribbean vacationers lounging poolside check their Blackberries for stock prices. Suburban gym members chat about the latest market gains during their morning workouts.
Welcome to the 2009 bull market -- or so many people think. They're buying up shares of everything from Google Inc to Bank of America Corp at a pace not seen since the 1930s. Since March, the Dow Jones industrial average has jumped 57 percent and the Standard & Poor's 500 index has gained 62 percent.
Investors are betting on a strong economic recovery. But here's the problem: Good news ahead could be bad news for the bull.
To understand why, consider the very thing that has boosted the market. The US government has spent nearly US$1 trillion to stimulate the economy and the Federal Reserve has maintained a policy of keeping interest rates near zero.
Those will disappear as the economy's health improves, potentially halting the bull market by taking away what has been its crutch -- sources of cheap and plentiful money. "Pretty soon the easy money phase could be behind us," said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors, an investment firm in Albany, New York.
The government has plunged big money into the marketplace, through tax cuts, construction projects and other measures. At the same time, low interest rates have invigorated stocks by reducing borrowing costs and bolstering corporate profits.
The low rates have also knocked down the returns of other short-term investments, like government bonds and money-market funds. Since people aren't getting high returns on those investments, they're buying stocks.
"The Fed is forcing everyone to take risk by buying stocks because if you don't take risk, you will be earning nothing on your money," said Ed Yardeni, president and chief investment strategist at Yardeni Research.
Yardeni said his clients, which include pension funds and institutional investors, feel like they don't have a choice but to buy stocks right now. He sees lots of "fully invested bears" -- investors who don't believe that investing in stocks makes sense right now because of the state of the economy, but they are buying anyway because they worry they might miss out on a bull run.
A strong economy is just what Yardeni and some others on Wall Street say could thwart the rally should it lead to higher interest rates and waning government stimulus.
The Fed isn't expected to act soon. The US central bank has kept the target range for its bank lending rate at zero to 0.25 percent since December. It pledged this month to keep that rate at a record low for an "extended period." How long that really means is anyone's guess.
In the past, higher rates didn't knock down stocks immediately. Back in 1982, a sustained bull market began amid a deep recession, and the gains lasted even though the Fed began to boost rates.
There was more to lure investors back to stocks then. Stock dividend yields were 6 percent then; today they are below 2 percent.
Investors still should heed the potential danger signs of today's market, before their exuberance gets the better of them.
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