The stock market is showing real strength at this time. A lot of stocks that were hit hard during the market’s recent correction are fighting back and making good progress in their share prices.
Consider Caterpillar Inc. (NYSE/CAT), which is an important benchmark stock to follow. The company’s second quarter came in slightly below expectations, then the market began to correct. The stock was around $112.00 and dropped like a stone to $82.00 per share. After experiencing a recovery to just over $90.00 a share, it dropped again to the $80.00-per-share mark. Now the stock has broken past the $93.00-per-share level and its near-term price momentum looks to be intact.
There’s a number of other large-cap, benchmark companies experiencing the same kind of trading action, and it’s a sign of two things in my mind. Firstly, the market overreacted to the downside after Standard & Poor’s lowered America’s debt rating. Secondly, institutional investors are starved for places to invest. They will continue to purchase shares of well-managed, higher-dividend-paying stocks, because there is no other place to invest their money.
In a sense, there is now much more stability in financial markets. The sovereign debt issue is known, monitored and priced in. The outlook for U.S. interest rates is now extremely stable, because the Fed just told us so. This is creating more stability in currencies, especially the U.S. dollar. Investors are aware of the slow growth in mature economies and are also aware of reduced expectations in emerging markets like the Chinese economy. My view is that the U.S. stock market is appropriately valued at the moment and that all the market-leading news is fully priced into share prices. It’s therefore a market that can go up in anticipation of third-quarter earnings and the possibility of better times ahead.
Right now, we are getting all kinds of divergent economic news. One week, mortgage applications show a huge decline; the next, private sector payrolls have increased. The choppiness of the stock market reflects the choppiness of the underlying economy…and I don’t think this is going to change until well into 2012.
Accordingly, there isn’t a catalyst or a lot of cause for equity investors to be taking any bold, new actions. The fundamentals don’t support major new investment action if you have money sitting in your account, waiting for something in which to invest. Large-cap companies are outperforming, because they are the ones that pay decent dividends to shareholders. With little expectation for growth from the underlying economy and therefore in capital gains from stocks, the dividend has become the equity investor’s new best friend.
I think that the stock market’s recent trading action has been very encouraging. Investment risk remains high for all new equity positions. But then again, nothing else pays with interest rates so low.