I’m frequently asked the same question when I address economic conferences or make special presentations to groups of CEOs or financial analysts. The question is, “What is your prediction regarding the stock market?”
My normal reply is, “It will fluctuate”! While this response usually draws some chuckles and nodding agreements from members of the audience, it’s usually not enough of an answer. Therefore, I follow up that statement with an explanation of the reasons for the volatility of the market and then conclude with a discussion of some of the things that traditionally drive it.
To understand the stock market, it is necessary to recognize that it is a reactor. Among the various matters to which it reacts are such things as world events, political activities, corporate scandals, and earnings reports. Most of all, the market is an indicator of investors’ opinions about the future. For example, if a company misses by just a penny per share the expected quarterly earnings level, some potential investors believe the company might be in trouble, when in reality it may still be very healthy.
If investors perceive the general economy is headed south in a hand basket, fears about tomorrow may cause them to seek to enhance their financial resources through means other than the stock market. If they believe the light at the end of the tunnel is going to get bigger and brighter, they are more willing to get on the train headed for greater opportunities.
That said, what does the picture look like right now? How are investors viewing the possibilities for tomorrow? What has developed to expand the current interest in the stock market? What are the forces driving it?
Investors have entered the market this month fueled by the continually improving economic picture. The nation is now in its 30th month of recovery. One of the motivators for expanding investor participation in the market is the expectation that interest rates will likely remain low. High interest rates tend to cause people to keep their money in banks where they can earn a good return on bonds and CDs and avoid the risk of the market. Low interest rates result in smaller returns from banks and bonds, so the desire for greater profit generally leads to a rise in participation in the market. Lower interest rates also spark people into making loans to buy goods and services with a corresponding expansion of the economy.
Interest rates play an important role in business operations because they influence corporate borrowing, which, in turn, affects corporate profits and prospects.
Although there is an underlying anticipation that interest rates will eventually experience an increase, many investors are not overly concerned right now because they see the hike not occurring until job growth advances significantly. For some, that time is expected to be much later in the year, or perhaps even in early 2005.
While inflation is always waiting in the wings, as long as the economy keeps growing around the 4% level, investors are betting that inflation won’t get much of an opportunity to advance to center stage.
Another force that is driving the interest in the stock market is consumer spending. In January, consumers opened their pocketbooks and wallets sufficiently wide to enable spending to climb a solid 0.4%, thus helping to keep the recovery moving along a positive line. Consumer spending, of course, is responsible for about two-thirds of all economic activity in the US. Thus, as spending increases, the economy correspondingly benefits. With tax refunds hitting the mailboxes soon, expectations are that spending will continue at a solid pace.
Businesses are also contributing to the advancement of the stock market by boosting capital spending, and manufacturing is beginning to replenish supplies and products that have diminished as a result of consumer purchases and prolong skittishness. Broader job creation is now eagerly anticipated.
The upward swing of the stock market today is reflective of the brightness of the economy, which is expected to continue to strengthen and expand over the immediate future. While specific sectors may move ahead or fall back to varying degrees (a subject for a future column), the over-riding sentiment at the moment is positive. As long as that remains the case, we’ll continue to see growth in the market.