Saturday, April 28, 2007

Stock Market Highs and Economic Growth: Weekly Archive Strolling

The big economic news of the week was yesterday's yucky GDP report, which was perversely greeted by a new record high for the Dow. A piece from this week's Business Week summarizes:
Dow Hits New Record After Weak GDP

The Dow Jones industrial average finished the week at another record high, while the broader market lagged behind after a report showed that first-quarter gross domestic product (GDP) growth slowed to 1.3%, much weaker than expected and the slowest pace in four years, while an inflation reading picked up steam. Microsoft's (MSFT) jump in profits helped keep some buyers around.

The stock market has considerable buying power despite numerous skeptics, says S&P. Some investors were looking to Monday's reports on personal consumption, construction spending, and the Chicago PMI for guidance after the soft GDP and high inflation numbers left traders confused, says S&P.
Now, to the archives. Here's another piece from Business Week, this time from the issue of June 25, 1990.
Will the Rally Pull a Fast Fade? Not This Time

Remember the adage "Fool me once, shame on you; fool me twice, shame on me"? That explains why, even with the Dow Jones industrial average above 2900, stock market investors are far more jaded than jubilant. In the summers of 1987 and '89, the market took big strides and scored new highs -- only to get clobbered in the fall. So those already in stocks are wondering if it's time to get out, and many on the sidelines are afraid to come in, for fear they'll be fooled yet again.

But the timid might be the ones who get fooled this time around. The Dow is on a roll. After setting a new record of 2935 on June 4, the market made a quick retreat to 2862, only to come bounding up again. Profit-taking is normal and to be expected after the breathless runup of nearly 300 points, or 11%, in six weeks. The Dow has climbed more than 15% from its midwinter bottom.

"This market is for real," says Stephen Poling, chief investment officer of AMEV Advisers Inc., a top-performing mutual fund group. "Back in January, I would not have believed the market could snap back this way." Byron R. Wien, U. S. equity strategist for Morgan Stanley & Co., forecasts the Dow will hit 3100 before yearend.

The zip in the popular stock averages is coming from companies that show a steady rise in profits quarter after quarter, a trend that started last year. And what really separates the leaders from the rest of the pack this year is their booming business abroad... Overseas revenues will become increasingly important for many U. S. companies, says Edward M. Kerschner, chairman of the investment policy committee at PaineWebber Inc. "Many American-domiciled companies have more coming from outside the U. S. than from within," he adds. Last year's winners, such as Coca-Cola, Disney, and Procter & Gamble, are still stars -- and they look overseas for revenues.

The resurgence of technology stocks is also striking. Since the beginning of the year, the Hambrecht & Quist High-Tech Index is up 13.2%, vs. only 3.3% for the Standard & Poor's 500-stock index. Investors have spent nearly three times as much on technology stocks than energy stocks, the second-most-favored stock group (chart).

But there's more to this market than overseas sales and a high-tech comeback. There's cash, and plenty of it. Mutual funds, which have record cash reserves, have far and away been the major buyers of stocks this year (chart), along with individuals, small institutional investors, and foreigners. And the betting is that with yields on short-term cash investments such as money-market funds and certificates of deposit falling, investors will turn to stocks and equity mutual funds. In fact, the slump in real estate, the quagmire in junk bonds, and the boredom in precious metals all work to the stock market's benefit: It's the only game in town.
Note that the economy officially went into recession in July 1990. Here's the picture showing US economic growth immediately following these record highs for the stock market in June 1990:

When someone asks you why the stock market is at a record high right now even though economic growth is weak, there are a number of plausible answers, I think, including: corporate profit growth that has been strong even as the economy has been slowing, and stock market investors take their cues from corporate profits; a large number of investors are more backward-looking rather than forward-looking (and thus, in economic terms, "boundedly rational"); and the enticing and ever-likelier prospect that we will soon be entering an environment of falling interest rates, which make equities more attractive in general.

But if you don't like any of those explanations, or simply don't want to wade into them in depth, here's another way to answer that question: just shrug, and say wisely "it's happened before."


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