With declining expectations for future economic growth and therefore corporate earnings, the stock market could experience a prolonged period of range-bound trading action around current levels. The S&P 500 Index has been trading in a tight range around 1,150 since the beginning of August and, while there’s been resiliency around the 1,120 level, there’s also been some serious resistance around 1,220. This 100-point trading range has experienced all the sovereign debt turmoil as well as the realization of slower domestic growth over the coming quarters. The future, it would seem, is so uncertain on the growth front that it makes the case for zero expectations for share price appreciation.
This is why dividends have become so important in this market, particularly to institutional investors. Expected return on investment in the stock market is so low now that large investors have somewhat capitulated by migrating to higher dividend-paying stocks, with the sole expectation of being able to generate at least some returns from equities. At the very least, there is the prospect of earning a return that beats the current rate of inflation.
While the stock market is in correction/consolidation mode, there are a number of higher-dividend-paying stocks that are trading near their 52-week highs. A lot of these stocks belong to the Dow Jones Industrial Average and, quite frankly, in many cases, I think it’s their dividend yields that are keeping these positions aloft.
It used to be that the Federal Reserve was the policymaker of last resort that could soothe the needs of the investing marketplace, but with so much stimulus already expended after the subprime mortgage debt crisis, the central bank is basically out of moves. So, there isn’t going to be any one catalyst to jump-start the economy or the stock market. The only thing that remains is more time to get the system to balance itself out, eat through the excess inventory (of homes and other assets), and begin a new business cycle. Central banks around the world have arguably done a decent job of trying to smooth out the business cycle over the last few decades. Now they are out of options.
Of course, the cause of all the current mediocrity is debt. Individual debt and sovereign debt. Corporate debt is very much in check these days, with strong corporate balance sheets fueled by cash hoards and interest rates that are very low. But, because of the debt-induced global recession, returning to a period of higher-than-inflation economic growth is going to be very difficult until sovereign debt becomes more manageable. The austerity will be painful, but it’s a necessary action in order to restore the business cycle in mature economies and restore investor confidence.
Over the very near term, it’s fair to say that investment risk for anything other than cash is very high. It’s difficult to get a true handle on the sovereign debt problems in Europe and, more importantly, the European banking industry’s exposure to it all. So far, we’ve seen some austerity measures on government spending and mostly new debt to bail out Greece’s finances. What I believe is that the world’s debt problems are far from over and, because of the potential risks to the euro currency, strength in the U.S. dollar as the world’s reserve will keep equities, commodities and bonds in their current period of range-bound mediocrity.