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By Rachel Beck, Associated Press
NEW YORK — Somebody on a bus asks a friend, "How about that stock market?" The response: "Unbelievable." Caribbean vacationers lounging poolside check their Blackberries for stock prices. Suburban gym members chat about the latest market gains during their morning workouts.
Welcome to the 2009 bull market — or so many people think. They’re buying up shares of everything from Google Inc. to Bank of America Corp. at a pace not seen since the 1930s. Since March, the Dow Jones industrial average has jumped 57 percent and the Standard & Poor’s 500 index has gained 62 percent.
Investors are betting on a strong economic recovery. But here’s the problem: Good news ahead could be bad news for the bull.
To understand why, consider the very thing that has boosted the market. The U.S. government has spent nearly $1 trillion to stimulate the economy and the Federal Reserve has maintained a policy of keeping interest rates near zero.
Those will disappear as the economy’s health improves, potentially halting the bull market by taking away what has been its crutch — sources of cheap and plentiful money.
"Pretty soon the easy money phase could be behind us," said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors, an investment firm in Albany, N.Y.
MARKETS AT A GLANCE
The government has plunged big money into the marketplace, through tax cuts, construction projects and other measures. At the same time, low interest rates have invigorated stocks by reducing borrowing costs and bolstering corporate profits.
The low rates have also knocked down the returns of other short-term investments, like government bonds and money-market funds. Since people aren’t getting high returns on those investments, they’re buying stocks.
Stocks are risky because they don’t guarantee a return, and the recent bear market shows how deeply share prices can drop. From October 2007 through March, the Dow industrials lost 53 percent.
"The Fed is forcing everyone to take risk by buying stocks because if you don’t take risk, you will be earning nothing on your money," said Ed Yardeni, president and chief investment strategist at Yardeni Research.
Yardeni said his clients, which include pension funds and institutional investors, feel like they don’t have a choice but to buy stocks right now. He sees lots of "fully invested bears" — investors who don’t believe that investing in stocks makes sense right now because of the state of the economy, but they are buying anyway because they worry they might miss out on a bull run.
The Dow is trading above 10,000 for the first time since October 2008, though it is still 27 percent below its peak two years ago. The S&P 500 has gone up almost 7 percent just this month.
Plenty of investors and analysts don’t see an end to those gains, especially if the economy picks up in the coming months. But a strong economy is just what Yardeni and some others on Wall Street say could thwart the rally should it lead to higher interest rates and waning government stimulus.
The Fed isn’t expected to act soon. The U.S. central bank has kept the target range for its bank lending rate at zero to 0.25 percent since December. It pledged this month to keep that rate at a record low for an "extended period." How long that really means is anyone’s guess.
The Fed said in a statement after its November meeting that economic activity has "continued to pick up" and that the housing market has strengthened — a key ingredient for a sustained recovery. But a 10.2 percent unemployment rate and weak consumer spending is still plenty worrisome to the economy’s overall health.
Yardeni thinks once the Fed even begins to hint of looming changes in its interest-rate policy it will "take the steam out of this rally," he said. "It won’t take much to push this market back down."
In the past, higher rates didn’t knock down stocks immediately. The Fed cut its benchmark rate from 2001 through 2003 to stimulate growth, taking it down to a low of 1 percent, where it stayed for a year. The low rates reduced mortgage costs, feeding the housing boom, and sparked a bull market in stocks.
The Fed started to slowly raise rates in July 2004 to slow the economy and keep inflation in check. The housing market peaked in 2006 and the stock market followed in 2007. After that, both headed into a free fall.
Back in 1982, a sustained bull market began amid a deep recession, and the gains lasted even though the Fed began to boost rates. There was more to lure investors back to stocks then, notes David Rosenberg, chief economist and strategist at Canadian wealth management Gluskin Sheff.
Stock dividend yields were 6 percent then; today they are below 2 percent. That means investors had a greater potential to generate income off their stock investments, regardless of whether prices rose or fell. Bond yields were at double-digits and were expected to fall in 1982; today short-term bonds pay nearing nothing and yields will likely head higher. That could make fixed-income investments more attractive.
Investors still should heed the potential danger signs of today’s market, before their exuberance gets the better of them.
Editor’s note: Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org