Trader Eric Schumacher, centre, on the floor of the New York Stock Exchange, Feb. 21, 2012. Stock markets have climbed steadily this year, primarily because of optimism about the economy.Richard Drew/Associated Press
In a matter of weeks, global stock markets have shot from deep anxiety to growing optimism.
In one sign of investors' ebullience in recent days, the Dow Jones industrial average briefly broke past the 13,000 mark, a number it last saw back in 2008, just before the financial panic hit. Toronto stocks rose in tandem with the Dow, as did other bourses around the globe, while prices of commodities from oil to gold rocketed higher.
The market's mood is in dramatic contrast to its state in December, when doom and gloom pervaded trading floors. With Greece's debt crisis threatening to undermine the euro zone, many investors feared an outburst of financial mayhem, like the one that accompanied the collapse of Lehman Brothers in 2008. European banks were too frightened to lend to each other and there were worries that Italy was about to follow Greece into insolvency. Adding to the downcast mood was evidence of slowing growth in Europe, Japan, Canada and even China.
All that seems like ancient history now.
"The bad luck of 2011 has begun to wear off," says Eric Lascelles, chief economist for RBC Global Asset Management in Toronto.
Two developments lie behind the change for the better. A big plus is that the U.S. economy has exceeded expectations and delivered surprisingly strong job growth. Even more important, though, have been the bountiful quantities of liquidity that central banks have injected into the financial system, which has helped to stabilize European markets in particular.
"I think it makes absolute sense that the stock market has had a real great ride the past few months. Europe is much less worrisome than it was and the [U.S.]economy is much stronger," Mr. Lascelles says.
In rapid succession over the past three months, the European Central Bank, Bank of England and Bank of Japan announced plans to pour massive amounts of new cash into the global financial system. Meanwhile, the U.S. Federal Reserve Board pledged to keep short-term interest rates near zero through to 2014, a promise that may require more money printing.
Michael Hewson, senior market analyst at CMC Markets in London, dates the change in investor sentiment to Dec. 9, the day after the European Central Bank said it would be offering virtually unlimited amounts of three-year money to banks at the rock bottom interest rate of only 1 per cent.
Later that month, banks took the ECB up on its offer and borrowed a staggering €489-billion ($658-billion). That wave of cash has carried European stock markets to double-digit gains since the start of the year despite growing evidence the continent is slipping into recession.
More recently, the Bank of Japan said it will push an additional ¥10-trillion ($123-billion) of newly minted money into its economy, while the Bank of England announced plans to jump-start Britain's lacklustre recovery with a £50-billion ($79-billion) shot of fresh cash.
"You put it altogether you [have]very easy monetary policy [and]very low or negative interest rates. That money has to go somewhere," Mr. Hewson says. "How else do you explain that even though the economic data have been, shall we say mixed, at best, the equity markets have gained 15 to 20 per cent?"
If injections of money from central banks have been the main fuel for investors' high spirits, the good times could get another boost as early as this coming Tuesday, when the ECB has scheduled a second offering of three-year loans for European financial institutions.
There are whispers that banks, just as they did in December, will grab another €500-billion or so of ECB money. If so, that could provide yet another shot of stimulus to surging stock prices. "It's like a junkie waiting for the next fix," Mr. Hewson says of the mood.
With the market doing so much better, the big question is what lies ahead. Few analysts are willing to project that the recent gains can be sustained.
Mr. Lascelles says Europe, despite a recent deal to avert a Greek bankruptcy, remains "a pretty messy place." Economic growth in the U.S. could also slow as the year progresses, although the near term looks fairly strong.
"The stock market is unlikely to be on fire in that kind of environment, but nor is disaster likely," he adds.
Mr. Hewson is concerned that the market may be about to surprise investors who have become so used to the recent easy gains that they've become complacent about the risks. "I certainly think there is a danger that it's becoming a little bit overextended on the up side. People are a little bit too optimistic," he says, calling valuations "stretched."
One of the most bearish assessments comes from Gary Shilling, president of Gary Shilling & Co. Inc., a New Jersey money manager and economic consulting firm, who says 2012 could play out similarly to 2011.
In early 2011, just as now, stock and commodities were on a tear. They were upended later in the year by European debt jitters and the bitter political battle over increasing the U.S. debt ceiling.
Mr. Shilling is bearish on both U.S. economic growth and the stock market. The S&P 500 index could fall to 800 by year end, down a painful 40 per cent from current levels, he says.
Among the economic negatives he sees are a dramatic slowdown in Chinese export growth. In addition, U.S. consumers haven't had the income growth they need to maintain current spending levels. Instead, they have been cutting into their savings to support consumption. Corporations have boosted their bottom lines mainly through cost-cutting, rather than growing revenue, something that can't continue indefinitely.
Then there is Europe. "Europe is in a recession that promises to be deep because it combines a financial crisis with a … real-economy recession very much like we saw in Europe and the U.S. in 2007-09," he says.
His advice: plunk money into U.S. Treasuries because they'll rise in price as economic hard times and deflation take hold. The 30-year Treasury, currently yielding about 3.1 per cent, could rise in price enough to bring its yield down to 2.5 per cent, he says.
In a note to clients this week, the Montreal-based brokerage firm Brockhouse Cooper noted that "optimism abounds." Growth projections are being revised upward, and everything looks much brighter than it did.
"But have we gotten ahead of ourselves? Is the growth that is now priced in realistic? We think there is a large risk that data will disappoint in the coming months, leading to poor performance for risk assets," it warned.