The stock market bounced back from an oversold position (although a week later than I thought it would), but there aren’t too many reasons why it should go upward. For the most part, earnings growth is expected to be flat in the fourth quarter. The eurozone is in recession, and Germany expects next year to be tough. And there is the prospect of new austerity measures in both Europe and the U.S. So, other than the highest-yielding stocks, there isn’t a lot of reason to be a buyer in this market.
Some corporations increased their dividends this year, but I would say more are choosing to buy back their own shares instead, and this is troublesome. This means that investment capital is not being reinvested in a new plant, equipment, or employees, and shareholders aren’t really getting ahead. It’s kind of like a corporation implementing its own austerity measures, while trying to keep shareholders happy. A lot of corporations are using this environment of artificially low interest rates to borrow money from the bond market, and then use it to repurchase their own shares on the stock market, which is not a good long-term strategy.
So while I’m not bearish on the stock market, I’m realistic. The interest rate cycle does favor equities at this time, but it’s a pretty good bet that interest rates aren’t going to go down any further. I’d be very reticent to be a buyer in this market, not just for the reasons mentioned above; but also because investment risk for stocks is very high. (See “Warning: QE3 Rally Is Now Over.”)
Austerity measures are required in Europe because of the region’s sovereign debt problem. They are also required in the U.S. because of the annual deficit; but new austerity measures for the U.S. mean the country risks falling back into recession. Austerity measures are a double-edged sword; they are required, but in a reasonable way.
To me, when the S&P 500 is below 1,400, it represents a stock market that’s breaking down. This week’s bounce-back was on very low volume, which signals a real lack of conviction in equities. Economic data from China are showing an uptick, but this isn’t enough of a reason to be a buyer in the U.S. stock market. With the prospect of new austerity measures in both the eurozone and the U.S. in 2013, dividends will likely be the only investment returns from stocks.