Stocks seem wildly overvalued and the world looks more threatening by the day. Is it time to latch on with the crowd that sells in May and goes away?
Not so fast. Like it or not, say some market sages, it’s the Ben Bernankes of the world who will decide the fate of the stock market — and for now, signs point to a continued, if often disjointed and occasionally hair-raising, rally.
“The cost of money is going to be near zero for at least another year,” said David Kotok, chief investment officer at investment adviser Cumberland Advisors in Vineland, N.J. “Over time that will lift the value of financial assets such as stocks that are sensitive to rates.”
This is not an order to drop what you’re doing and empty your bank account for the sake of loading up on Sirius and claims on the GM estate sale. But it’s a reminder that stocks’ bizarre run-up may not yet be over.
Kotok, for one, says he expects the S&P 500 index of big company stocks, down 25 in Thursday’s selloff at 1090, to hit 1250 — in line with its level before the September 2008 collapse of Lehman Brothers.
Update Friday 9:36 am: Stocks certainly aren’t rallying now. The S&P fell 11 points at the open Friday to 1060.
He isn’t the only one who expects stocks will be buoyed by the currency printathon going on at the Federal Reserve and the other big central banks. Value investor Jeremy Grantham said in his quarterly note to investors last month that Bernanke, by keeping the Fed’s policy rate near zero, “is, in fact, begging us to speculate” on assets like stocks.
Grantham doesn’t rule out a stock selloff but calls a continued rally the line of least resistance. And the Fed’s current policy, which holds rates low for the sake of propping up asset prices and restoring banks to solvency, isn’t the only thing on Grantham’s mind.
In October, he notes, we’ll enter the third year of the U.S. presidential election cycle, which he characterizes historically as “the year every Fed except, of course, Volcker’s, helped the incumbent administrations get re-elected.”
While there are still those who believe the Fed will raise rates next year to head off inflation threats, Grantham is not among them. That could support stocks, which some bears say have been in bubble territory for the better part of a year, well into 2011.
“Do not think for a second that a very stimulated market will go down in Year 3 just because it’s overpriced … even badly overpriced,” he writes. “So far it has had 19 tries to go down since 1932 and has never pulled it off.”
That’s not to say the ride will be relaxing. Volatility is back, as investors grapple with an ever-evolving set of risks.
Those include, to name just a few, rising taxes, tougher regulations and political turmoil. Take the German bid to limit short-selling. Authorities billed the measure as one that would restrict the role of speculators, but it may instead have had the effect of making all investors more cautious.
“This is an environment where regulation can have a significant impact on market psychology,” writes Tullett Prebon economist Lena Komileva, “because for the first time in over a year policy is not having a corrective, stabilizing effect on the markets and small policy actions can add to overall market uncertainty and lack of liquidity.”
And don’t think for a minute that a continued rise in stocks is an unalloyed good. Indeed, Grantham argues that a drop in the stock market now could be salutary for over-leveraged Western economies, which are already being tested by worries that they won’t be able to shoulder the debt burdens they’ve taken on in bailing out reckless bankers.
A stock rout now, he writes, could “be enough to break the market but still leave the economy limping along. This would be far better than having the market rise through the fall of next year by, say, another 30% to 40%, along with risk trades similarly flourishing and then all breaking.”
Were that to happen, he writes, “The developed world’s financial and economic structure, already none too impressive, would simply buckle at the knees.”
But enough of the apocalyptic talk. For now, Kotok says, the lesson is that “there will be a strong corrective dip, and it will be a buying opportunity.”
