Why Are So Many Stocks Hitting New Highs in the Face of Very Big Risk?

Hitting New  HighsThe sovereign debt crisis in Europe is now flaring up again, as newly proposed austerity measures are not being well received, particularly in Spain and Greece. This summer, the stock market mostly ignored the sovereign debt crisis as European policy makers took some action to show more cohesion in dealing with the issue. At the end of the day, however, they can’t fix the problem with bailouts and more debt (just like in the U.S. economy). Austerity measures in the form of government spending cutbacks likely will keep the eurozone in a no-growth environment for most of this decade.

Right now, the stock market continues to get a reality check after its recent summer rally. Volatility is on the increase, especially before third-quarter earnings season begins. I don’t see a lot of reason to take much in the way of new action in this market. We’ve had a decent rally and an uptick in U.S. economic data. The economic news out of Europe reveals that there continues to be no growth and China is on track with its policy-induced economic slowdown, trying to get inflation and a property bubble under control.

Earnings warnings haven’t been unusual so far, and last quarter, corporations were very conservative with their outlooks. So my bet is that we’ll see a lot of upside surprises this earnings season and corporate visibility for the fourth quarter will be good. You could argue, however, that in this scenario, the stock market’s recent run-up in prices and capital gains are done for the year. Certainly, it will be difficult for the main stock market indices to keep rising without meaningful earnings growth and increased outlooks going forward.

There’s been some breakdown among the stock market’s best performing stocks, but not much. An earnings warning from a brand-name company will retreat an entire stock market sector, but if you look at many the Dow Jones Industrials component stocks, you’ll find that the majority are trading right at their 52-week highs. (See “Stock Market: Will it Heed the Warnings?”) AT&T Incorporated (NYSE/T) is a great example. Its stock chart is featured below:

 AT&T Chart

Chart courtesy of www.StockCharts.com

In the large-cap space, we know that technology stocks continue to be strong. Telecommunications stocks are doing well; pharmaceutical, healthcare, and consumer goods stocks are doing well, and surprisingly, so are the financials. And for the most part, a lot of market leading blue chips are not expensively priced. So the result of this is that the stock market is trading where it should be, given current earnings, and there remains good potential for incremental gains over the next few months.

The sovereign debt crisis in Europe is a real threat to your pocketbook in 2013; there’s no doubt about it. But, it’s been a threat for some time now, and the stock market has still gone up on the back of decent corporate earnings. At the end of the day, institutional investors will still be buyers in this market because earnings, while not robust, are still growing and when combined with dividends, they offer investors the only real way to beat the rate of inflation. The stock market is due for a pullback, but the near-term upward trend looks intact. Third-quarter earnings season is the next big catalyst for sure.