Thursday, February 9, 2012

What If the Markets Continue to Move Higher?

The markets are off to a strong start this year.

The S&P 500 is up more than +7% year-to-date, while foreign markets are generally up even more.

Although the economic news is undeniably getting better - last Friday's positive jobs report, for example, marked the 23rd consecutive month of positive job creation - the chorus of analysts and economists "fighting the tape" has grown ever louder.

After such a quick move higher, it does seem likely that we could see a mild market correction at some point.  But I think any correction would present an buying opportunity.

The problem with many of my investment management brethren, in my opinion, is that most share a fairly cynical view of the world.  After the last decade of feeble equity market returns, it is a much more comfortable stance to worry about all of the possible ways that the economy and markets could nosedive again.

But The Economist carried a blog a couple of days ago that asked a fairly provocative question:  If, in 2008, the Fed had stepped in and bailed out Lehman Brothers rather than let it fail, could the subsequent market collapse been avoided?

Or, put another way, what if the combined efforts of the European Central Bank and the Fed have staved off economic disaster in Europe at the end of last year?

If a Lehman-type collapse is no longer possible - at least for the near term -  is it possible the global markets could have a serious move higher based on the massive amounts of liquidity in the system?

To me, this is really what is going on in the markets right now.  Cash and bonds offer unappealing returns, making stocks the only game in town for anyone investing for the future.  The economy may not be robust, but it is going in the right direction, and for now that might just be good enough.

Here's an excerpt from the Economist piece:

And then it's impossible not to wonder: should Lehman have been saved? How might things have been different if the Fed had simply thrown gobs of money at the financial system? How might the euro crisis have gone differently? It's surprising how difficult it is to avoid thinking about the situation moralistically—to feel that there was indeed something good and purging in the near-collapse of the financial system. There wasn't, though. Lehman's shareholders were punished severely, but the vast majority of financial institutions made it through all right, despite the fact that their behaviour hadn't been much better than the victims'. And meanwhile, millions of workers and businesses suffered tremendously despite having done nothing wrong.

Still, what the central bankers giveth, they can also remove, as this Liam Halligan wrote earlier this week in the London Telegraph:

It must be said, though, that this shift in market sentiment was not sparked by any improvement in the economic fundamentals. What we’re seeing in the macro numbers, on the contrary, is evidence of further European economic deceleration and a rising chance of recession in some of the world’s biggest economies. 

What caused this rally, of course, was very explicit reassurances that the “big four” global central banks (the US Federal Reserve, the Bank of Japan, the Bank of England and, increasingly, the European Central Bank) will keep providing practically unlimited funds at interest rates close to zero. 

At the end of last year, the ECB pumped the best part of half a trillion euros of credits into the eurozone’s addled banking system. The markets expect that, now the Rubicon has been crossed, and German Chancellor Angela Merkel “finally gets it”, there will be much, much more to come. This outcome is now not so much a working assumption among traders, but more an article of faith.

In the end, money moves stock prices, not economic data or political rhetoric. 

And right now that money is moving into stocks.