Tags: stock market | recovery | share prices | economy

Good and Bad of the Strong Stock Recovery

By    |   Monday, 03 November 2014 08:09 AM

The stock market’s rally in the second half of October was equal parts rapid and forceful. Yet its implications are, unfortunately, far from decisive.

In two short weeks, the Standard & Poor's 500 Index rose 8 percent, more than recovering its 7 percent drop in the prior four weeks. In the process, it quickly set a new record (as did the Dow Jones Industrial Average), surprising those expecting a longer process of market consolidation after what had been a 19 percent gain in the previous year and 44 percent over two years.

Compounding the surprise was that the strong market recovery occurred in the context of less Federal Reserve stimulus and increasing concerns about the global economy.

Four factors contributed to the October turnaround. Solid corporate earnings releases, with the average gain of 10 percent in earnings per share exceeding analysts’ expectations.

Second, investors have been conditioned to buy on dips, a strategy that has repeatedly worked well.

In addition, considerable cash was (and still is) sitting on the sidelines.

Finally, and most recently, the Bank of Japan unexpectedly decided to increase its monetary stimulus program.

Yet the impressive and steep “V-shaped” rebound of stocks wasn't replicated across all markets. The recovery was partial for U.S. government bonds and, more noteworthy, it was totally nonexistent for oil. In fact, oil prices ended the month down about 11 percent.

There are reasons specific to the energy sector that help explain the decoupling of oil prices from stocks.

For example, the resumption of Libyan production bolstered what already were relatively robust supplies. Meanwhile, geopolitical risks receded somewhat as air strikes against Islamic State reduced worries about further supply disruptions in Iraq.

But there are other issues of broader relevance, and the equity markets won't be able to sidestep them forever, should they persist and deepen. The sensitivity of the oil prices to increased central-bank stimulus measures — first out of Japan and soon out of Europe — has become less pronounced, given the lower-than-expected impact these policies have had on growth and on economic (as opposed to market) risk-taking.

At the same time, the demand for oil is undermined by a global economy that, beyond the U.S. and the U.K., is still slowing, as highlighted by this weekend’s disappointing data on Chinese manufacturing activity.

Investors have good reason to cheer stocks’ impressive recovery in the last two weeks. But their exuberance should not detract their attention for too long from a simple proposition: An improvement in fundamentals will be needed at some stage to validate existing prices.

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The stock market's rally in the second half of October was equal parts rapid and forceful. Yet its implications are, unfortunately, far from decisive.
stock market, recovery, share prices, economy
Monday, 03 November 2014 08:09 AM
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