A Three-Year Bull Market: Feeling Better Yet?

Wall Street Journal

On March 9, 2009, the stock market hit its postcrash bottom. Today, after a three-year rally that’s seen the Dow Jones Industrial Average rise 98%, from 6547 points to 12978, investors are trying to understand how to explain the good fortune, and whether it will continue. « In March 2009, the stock market was priced for another Depression, » says James Paulsen, chief investment strategist at Wells Capital Management. « What we have come to realize is that the economy was probably never that close to depression and is now in recovery; consequently, valuations are being reversed. »

Adds John Brynjolfsson, who runs hedge fund Armored Wolf: « We’ve been to the depths of Hades and back. »

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One of the biggest factors behind the three-year burst for stocks: easy money. The Federal Reserve cut interest rates and took other steps to send interest rates plummeting.

That helped force many investors to shift into stocks from money-market funds, bank savings accounts and bonds. At the same time, companies took advantage of lower rates to refinance debt or sell new debt, allowing them to shore up their balance sheets. Corporations saw an earnings recovery, as many pared payrolls, became more efficient and enjoyed record profit margins. « Corporate earnings are at all-time record highs and have surpassed consensus expectations by persistently wide margins nearly throughout this recovery, » says Mr. Paulsen.

It helped that the Chinese economy has remained strong and continues to provide low-cost goods, and that stocks were at relatively inexpensive levels three years ago. It was a rocky three-year climb, however. Standard & Poor’s cut the U.S.’s triple-A credit rating last summer, large parts of Europe dealt with debt anxieties and slowing growth, and, most recently, oil prices have shot up.

Today, there are many positives for investors. Interest rates remain low and the Fed has promised not to raise rates any time soon. That has helped the housing market from falling even further—a lifeboat to the struggling economy.

The job market also is improving, though unemployment remains high at 8.3%. And while corporate profit margins are showing signs of slipping, they remain near all-time highs.

Still, Mr. Brynjolfsson and others note that many problems remain—or have been amplified—over the past three years. For one thing, governments around the world, including the U.S., have piled on debt as they spend to try to pump up the economy. That has put them in more precarious positions.

Stocks now are seen as fairly valued, and Tobias Levkovich, Citigroup’s chief U.S. equity strategist, warns of shrinking profit margins. He’s also worried politicians aren’t yet willing to address continuing fiscal imbalances.

A global « de-leveraging » is still taking place as consumers and nations try to trim their debts, something that likely will put a ceiling on both spending and growth.

Keep an eye out for growth in China and Germany. China has been able to keep its expansion going at an impressive pace over the past few years, despite concerns about both rising inflation and excessive debt and spending. If China sneezes, the rest of the world could catch a cold, especially commodity-related investments.

Germany too has been able to grow, despite marked weakness in Europe. But some analysts worry the nation may not be able to keep expanding, and all of Europe will falter.

That would cripple key markets for China, the U.S. and others. Either way, economic austerity in Europe likely will crimp global growth.

But the German stock market has been strong at the outset of 2012, a potential good sign for that country.

And investment firm Birinyi Associates says it is « impressed by the nature of the rally » in the U.S., because it « has been led by economically sensitive stocks and groups. » That could point to a stronger U.S. economy later this year.

In the short term, Mr. Brynjolfsson recommends junk bonds, which sport yields much higher than the skimpy yields of Treasury securities and benefit as the economy continues to regain its footing.

Over the long haul, Mr. Levkovich is a fan of stocks, arguing that U.S. manufacturers will be more competitive.

He sees technological advances in various industries, such as new mobile devices, and believes advanced drilling techniques will continue to keep a lid on natural-gas prices and help the U.S. move closer to energy self-sufficiency.

Jack Ablin, chief investment officer at Harris Bank, adds a note of caution, however, reflecting a view that U.S. debt issues will only get worse unless steps are taken to deal with them.

« Longer term, » he says, « either Washington makes difficult decisions or the markets are going to make them instead. »

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