Stock Market Defies Earnings by Going Up—Four-year High in Sight

Stock Market Defies Earnings by GoingIf you’re invested in this stock market, you have to be very careful over the near term. Frankly, this is an artificial market; one where share prices are going up on the hope that the Federal Reserve will employ a new round of monetary stimulus. Trading action isn’t robust, but this is a stock market that wants to go higher, and I think it will break a four-year high very soon.

The stock market isn’t going up on an improving earnings outlook; it’s going up on hope from the Federal Reserve. It is important not to go against Federal Reserve easing, but realistically, I don’t think there’s anything the central bank can do to help the U.S. economy further.

A lack of new monetary stimulus from the Federal Reserve is highly likely to result in a major stock market correction. I think they know this and members will take some new policy action. The only thing that could prevent a stock market correction if the Federal Reserve doesn’t act is strong economic news. If the Federal Reserve doesn’t have to act because the U.S. economy suddenly shows real strength, then the current stock market rally will be sustainable.

So, how do you describe the investment environment we’re in? It’s a total unknown really. There’s no real trend, with the exception that it’s an election year. The only fundamental strength that the stock market has, in my view, is its valuation, which is reasonable considering corporate earnings. This is a very tough environment in which to be a new buyer and with all the turmoil we’ve had in recent years, it’s no wonder that individual investors are sitting on the sidelines. Yet with this backdrop, I see the stock market ticking higher over the near term, and large-cap, dividend paying stocks should keep breaking through to new highs.

The next Federal Reserve meeting, known as the policy meeting of the Federal Open Market Committee (FOMC), is September 12–13, 2012. This policy meeting will also include a summary of economic projections and a press conference by the chairman, Ben Bernanke. It’s a critical date for the stock market, and while I don’t want to build it up, current investor sentiment depends heavily on what the Federal Reserve does at this meeting. (See “New Fed Action Good for Another Five-percent Gain in the Equities Market.”)

Since the subprime mortgage crisis, the Federal Reserve has been extremely accommodative, to the stock market and the U.S. economy. Interest rates are artificially low, and I’ve never seen a central bank more willing to appease Wall Street and investors. Therefore, it is likely that the Federal Reserve will do something to keep investors happy, even if it has no real effect on the U.S. economy.

In an environment with declining expectations for corporate earnings, the stock market has defied all rationality and gone up substantially (not including dividends). It is an incumbent election year, which history reveals is usually good for the stock market and policy makers in the eurozone are working hard and keeping things status quo. It’s, therefore, reasonable to expect the stock market will keep ticking higher this year, with the biggest investment risk over the near term being that the current hope of action by the Federal Reserve doesn’t happen. No doubt, it’s another wacky year for the stock market and investors.