By E.S. Browning
The stock market soared this week, reclaiming ground lost
earlier in the month. But many investors worried that, with stock
prices high and the world economy unsettled, this year's succession
of sudden dips and sharp recoveries may not be over.
Major indexes shook off the fears of global deflation that have
gripped U.S. and European markets. A surge of economic optimism and
strong corporate earnings pushed the Dow Jones Industrial Average
up 425.00 points, or 2.6%, this week, its biggest weekly gain since
December. The more volatile Nasdaq Composite Index rose 5.3% for
the week, its best weekly percentage gain since 2011. Both indexes,
and the broad S&P 500, are less than 3% from returning to their
September highs.
Better economic news from Europe and solid U.S. earnings reports
came on top of renewed hopes that European central bankers will
take fresh steps to support Continental economies, perhaps stepping
in to buy corporate bonds. International investors continued to
shift money to the U.S., where the economy has been one of the
world's steadiest and the Federal Reserve remains committed to only
a very gradual tightening of monetary policy.
David Kotok took a deep breath when stocks were collapsing Oct.
15 and jumped back into the market. Mr. Kotok, chairman of
money-management firm Cumberland Advisors, oversees $2.25 billion
in Sarasota, Fla., and he had cut his stockholdings during the
summer.
"We bought them in the middle of the bloodbath," he said, and he
has kept buying since, notably transportation, health-care and
utilities funds. Many others also have jumped in, fueling the
recovery. But in coming weeks, "the Dow could explode up 200 points
on some days and could fall 200 points on others. That will upset
some investors," Mr. Kotok said. His clients hate these churning
ups and downs, and he is spending more time than usual trying to
reassure them.
The Dow, at 16805.41 Friday, is up only 1.4% for the year, but
it has climbed 157% since bottoming out in 2009. The S&P 500 is
up 190% since the 2009 low, and the Nasdaq is up 253%.
But other kinds of investments haven't moved as much as stocks,
showing that concerns for the global economy haven't gone away.
Treasury-bond prices have pulled back during the recent rebound,
but only mildly, as traders have shifted to riskier investments.
Slow world growth and low inflation have kept yields far lower than
many thought possible a year ago, meaning Treasury prices, which
rise when yields fall, have remained high. Soft foreign growth has
held down prices of oil and industrial commodities. With the U.S.
one of the few places showing reliable growth, the dollar has
remained strong.
Money managers offer several reasons for the stock
volatility.
First, even after the recent pullbacks, stocks are no longer
cheap. The big advances since 2009 mean many people have
significant gains in their portfolios. They are quicker to cash out
when stocks fall, and they are having trouble finding
bargain-priced investments. The S&P 500 traded Friday at 18.4
times its companies' net earnings for the previous 12 months,
according to Birinyi Associates. That was down from about 19 at its
September high but is still well above its long-term average of
15.5.
Central banks, meanwhile, have stopped following the same safe,
reassuring policies. The U.S. Federal Reserve is getting ready to
start slowly raising interest rates next year, for the first time
since 2006. But Europe's central bank is still desperately trying
to loosen its policy. Shifting policies can make investors
nervous.
"If you look at what happens when the Federal Reserve takes
stimulus away, before it starts really strong tightening, the
markets have experienced about 50% more volatility than in the
period prior to that," noted Jason Pride, director of investment
strategy at Glenmede Trust Co., which oversees $28 billion in
Philadelphia.
On top of that, the world is still a scary place. Although
economic news from the countries that use the euro has improved,
eurozone economic growth still is running below 1% annually.
Chinese growth, while far from slipping into recession, also is
slowing. The nation's demand for industrial commodities has slowed,
hurting developing countries that provide them.
"Investors are a little bit on guard. They are a little bit
nervous about stocks right here," despite the gains, said David
Joy, chief market strategist at Ameriprise Financial Inc., which
oversees $810 billion. "I don't expect it, but it wouldn't take
much for volatility to come roaring back."
Mr. Joy is urging clients to keep a little extra money in cash.
A portfolio that typically would hold 60% stocks and 40% bonds, he
said, might today contain 55% stocks, 35% bonds and 10% split
between cash and hedge funds whose performance isn't linked to the
stock market's direction.
As long as the U.S. avoids recession, however, a little anxiety
actually can be good for stocks. Nervous investors are less likely
to go overboard and push shares to unsustainable levels. And when
people keep cash on the sidelines, it creates a pool of available
money that they may, if they become less nervous, shift to
stocks.
As the news has gotten better, that is what has happened.
Almost 70% of U.S. companies that have reported third-quarter
profits have beaten expectations, according to Thomson Reuters
I/B/E/S. That has included blue chips such as Microsoft,
Caterpillar and 3M, despite the struggles of some other big firms.
While the earnings gains have been unspectacular and typically
below 10%, they have been enough to reassure SHYinvestors.
Manufacturing reports from Europe also have improved, relieving
some fears, as have hiring, consumer-confidence and home-sales data
in the U.S.
Lower oil prices, meanwhile, give consumers more to spend on
other things than gasoline.
To the amazement of many bond experts, interest rates and bond
yields also have remained exceptionally low around the world. Low
rates are powerful economic stimulus, because they hold down
mortgage rates and the cost of business investment.
Among the reasons rates and yields are subdued: When inflation
and global growth are low, there is little to push yields
higher.
The 10-year U.S. Treasury note yielded 2.273% Friday, up only
slightly from its lows earlier this month and far from the 3% at
which it began the year.
And yet, U.S. Treasury notes yield more than government bonds in
Germany, Japan and even Spain. That, together with a strong dollar,
pulls money to U.S. Treasurys, supporting their prices and holding
down yields.
And as long as the U.S. economy can keep growing without
recession, many investors consider a severe stock decline
unlikely.
"We think we are in the middle of a longer-term global economic
expansion, mainly because we don't yet have the excesses that build
up in the system late in an economic cycle. We aren't seeing
corporate or individual debt buildup, excesses in manufacturing
capacity or overspending by consumers," said Mr. Pride of
Glenmede.
Write to E.S. Browning at jim.browning@wsj.com