Will the Stock Market Keep On Rising?

The forces that have boosted the prices of blue-chip stocks over the past year are diminishing, while other factors have become increasingly uncertain.

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Richard Drew / Associated Press

In this July 31, 2012 photo, specialist Gregg Maloney works at his post on the floor of the New York Stock Exchange. The market has had four straight losing days going into Friday, Aug. 3.

Since the beginning of the year, many commentators, including myself, have questioned whether stock prices can continue moving higher. Although there is a good long-term case for stocks, the market outlook has seemed increasingly risky this year and next. And yet, stocks keep going up, climbing a wall of worry, as the Wall Street expression goes. On Friday, in fact, the Dow reached its highest level since the recession began in December 2007. And over the past year, the index has gained more than 20%. Yet the question remains whether this trend can continue or whether another bear market lies just ahead.

Accurately predicting the direction of the stock market is a hopeless task, of course. But some sort of roadmap is essential since investment and other financial decisions do have to be made. What’s most helpful is to look at the long-term prospects for stocks, and then consider the specific factors that have helped lift share prices over the past 12 months.

The long-term case for stocks is fairly straightforward. During the 2007-09 recession, the prices of blue chips plummeted 56% and ended up deeply depressed. Since the recession ended, corporate profits have recovered strongly. And while share prices have risen considerably, they are still below their 2007 peak. Sooner or later, the overall economy will improve, and companies that are attractive now should be even more appealing.

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But what about the short-term outlook? To assess the market’s prospects in 2013, it makes sense to look at a list of factors that have boosted stock prices over the past few years and ask whether they are still positive. Here’s my list:

Cheap share prices. The chief reason stocks have risen over the past few years is that their prices fell to bargain levels during the 2007-09 recession. Stocks are normally evaluated by comparing share prices to companies’ profits (their so-called price/earnings ratios). Based on long-term profit trends, that ratio plummeted from 18 to less than 10 during the recession. Today it stands at about 16.5. Share prices have therefore made up more than three-quarters of their recession losses. They aren’t overpriced yet, but they’re no longer dirt cheap, either.

Rebounding corporate profits. Earnings for the S&P 500 are expected to grow 6% to 7% this year. Estimates for next year are all over the lot, from a further 10% increase to a decline. If share prices keep pace with future corporate profit growth, the overall stock market could rise another 10%. But even that best case doesn’t sound terribly impressive compared with the past year’s 20% price gain. And a decline in 2013 is possible as well.

Hot money. Some analysts argue that the U.S. stock market has benefited immensely from inflows of funds from Europe. Frightened investors in financially troubled countries such as Spain and Italy have been moving their money to safer countries, and it can’t all go to Germany, Switzerland and the U.K. But this is a self-destructing trend. While it may help bid up U.S. share prices in the short term, it’s actually promoting the deterioration of the global economy.

Fiscal stimulus. Traditional Keynesian economics predicts that a big government deficit boosts growth. Maybe it does. But with the U.S. currently running a deficit of more than $1 trillion a year, it’s hard to see how the current level of stimulus can be increased any further. If anything, the deficit will have to be reduced. And whether it comes from cutting spending or raising taxes, deficit reduction will be a drag on the economy.

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Easy money. The Federal Reserve has held short-term interest rates close to zero, their lowest level in more than half a century, in the hope of stimulating the economy. And the Fed has spent so much money buying bonds as part of its quantitative easing strategy that the monetary base (the amount of money outstanding) has more than tripled since the recession. Not only is it unlikely that the Fed can crank things up much further, even with another round of quantitative easing, but such policies can’t be continued indefinitely.

Election expectations. Some commentators have said that the market’s recent strength reflected improving chances of a Romney victory. It’s true that the Republicans were closing the gap with the Democrats going into the conventions. But if that had any effect on the stock market, it’s far from clear that it will continue. President Obama has started to pull ahead again since the conventions. And while these numbers can shift within the space of a week, the elections don’t seem likely to be a significant positive factor.

Euro zone risks. Stocks rally every time the euro zone postpones a crisis. But the fact remains that the economic situation in Europe keeps getting worse. At best, a currency crisis can be avoided. But the EU is already slipping into recession, and the sort of austerity policies needed to save the euro will only hurt growth over the next year or two.

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Going down this checklist, it’s evident that the factors that have been most positive over the past couple of years are diminishing or highly uncertain. And the rest, although they may be beneficial in the very short run, don’t hold much promise for next year as a whole.

More important, the rebound that stocks enjoyed since the end of the recession were largely the result of economics – depressed prices were snapping back and so were corporate profits. Today, by contrast, the factors that appear most influential are political – including the size of the deficit and Fed policy. While that doesn’t argue that a new slump is inevitable, it does suggest that in 2013 the stock market will be a riskier place, and that a higher degree of caution is in order.

12 comments
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johnkaainth
johnkaainth

In my views, every stock market is rising very rapidly in this time, although its Asian or European market. Recently i read an article here: http://www.trefis.com/stock/di...

After reading this article, its clear that Ny stock exchange is rising at very fast pace. Even Indian Market is also growing very rapidly and it has broken the last 2 years record.

http://www.profit.biz/

TheMovingFinger
TheMovingFinger

The short answer is yes, if given sufficient supply of idiots. We dont seem to lack in the latter.

Jfante1452
Jfante1452

The headline of this article is plain stupid. The market will never, ever keep rising. That's plain investments 101. In fact, the whole article is highly suspect. Trying to predict the market is like trying to predict the weather beyond a few days. It never moves in a straight line and rarely follows predictions. If it did, the author wouldn't be writing these articles.

Penny Stocks
Penny Stocks

A reason for stock market crashes is also due to panic and investing public's loss of confidence.

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Raymond Chuang
Raymond Chuang

The thing that could hammer the stock market is the German high court decision on the German participation on the European Central Bank bailout plan for Portugal, Spain, Italy and Greece. If this court rules that strict stipulations must be imposed before the implementation of the ECB plan, the whole plan could collapse and that could lead to a rapid collapse of the Eurozone and the possibility of a 30-40% drop worldwide in stock market values in a matter of _weeks_.

Smegacool
Smegacool

Just my opinion... but I don't think the economy is anywhere near finished "circling the drain". 

Example:  American Airlines in bankruptcy...to close main maintenance hub in Fort Worth effective Dec 2012... 1,050 personnel to be laid off.

MeMyself1234
MeMyself1234

Perfect. Now that Time is writing articles such as this, one can be assured a fall is near.