The stock market is like Pavlov’s dogs. It starts to salivate at the thought of a juicy meal, long before it gets one. (About a century ago, Russian scientist Ivan Petrovich Pavlov found that if he rang a bell before he gave the dogs meat powder, pretty soon they would salivate at the ringing of the bell.)
With the world in a funk (Europe on the brink, the United States growing only moderately), stocks have dipped a bit but done surprisingly well this year, largely because central banks have kept interest rates so low. It’s hard for stocks to go down much when banks — even foreign banks — can borrow money from the Federal Reserve for a very low interest rate.
For more than a year, stocks have soared whenever world leaders announced another plan to rescue Europe’s sick puppies — and the euro currency — with a snort of liquidity. American stocks zoom upward on the announcement, only to fall back a couple of days later when the new initiative proves to be mostly hooey. It’s happened more than half a dozen times. On November 30, American stocks zoomed 4 percent on the announcement that under a coordinated program, foreign financial institutions will have an easier time borrowing United States dollars from their central banks, which in turn would get the money from our Federal Reserve.
On Thursday, December 8, stocks plunged on fears of less liquidity. The next day they soared on expectations of more juice. The following Monday they plunged, continuing the weakness last week and through this Monday.
There will almost certainly be another flood of liquidity; our Federal Reserve says more juice could be forthcoming. So, like Pavlov’s dogs, the markets will salivate at the thought.
Del Mar’s Arthur Lipper III, a member of a legendary Wall Street family, says “investor enthusiasm in the face of widely known socioeconomic problems” puzzles some people, but given the coordinated loose monetary policies of the world’s central banks, there is a “vast amount of cash” available to institutional and individual investors.
And there is the Pavlovian effect: “Markets react to psychology before they do to statistics. Anticipation — the wish becoming the parent of the thought — dictates the trend. With so much money around and with more people making more money when markets go up, the wish for appreciation is understandable.” Governments, too, love rising markets, as tax receipts increase and politicians can justify more spending. The market may do well “at least until bleak despair is again present, as is likely at some point.”
Mike Stolper of Stolper and Company thinks the despair is already here and will help stocks. “I would be very surprised if we don’t have a huge rally,” he says. Many dejected investors are betting that stocks will go down; if there is good news, they will rush to buy stocks, pushing them up. “All it takes to spark a good rally is when sentiment gets so negative that virtually anything will spark a rally.” Dividends on blue chip stocks are higher than yields on cash or bonds. “Most people would argue that stocks are statistically cheap.”
Today, investors “want to believe that the apocalypse is not around the corner,” Stolper says. However, many believe that “There is not enough money on the planet to bail Europe out.” Europe may already be in recession. If it’s contagious, the American economy could slow sharply. “If you operate on the premise of having to reschedule or repudiate debt around the globe, we will have subnormal growth rates for some time.” Earnings would fall, and the market would be wary of stocks.
Robert Snigaroff, president of Denali Advisors, began buying stocks for his personal portfolio the first week of August. “Stocks have attractive yields compared to Treasury bonds and cash,” he says. His firm buys blue chip stocks, preferably with generous and safe dividends, and avoids financial equities. “Stocks have more upside than bonds.” (Bonds have been in a bull market since 1981; stocks have had a sloppy ride since 2000.) “I’m optimistic but cautiously so.”
Viewing the various initiatives to bail out Europe, Neil Hokanson of Solana Beach’s Hokanson Associates says, “This is like running a marathon. We’ve run the first quarter of a mile, all downhill. The rest is uphill — cutting entitlement spending, current and future, both in the U.S. and Europe. We just can’t sustain the programs put into place in the last 75 years. History indicates that it takes a crisis to generate structural reform.”
Hokanson says he is an optimist, but he is not bullish on the short run. “There is great latent potential for stocks if governments get their acts together,” he says. But things may have to get worse for politicians and bureaucrats to wake up, and the market may react negatively to the dallying approach to deep crises.
Still, “If you came down from Mars and looked for places to invest, you would pick common stocks,” he says. His firm is emphasizing dividends. “We believe in investing globally, but the U.S. is the place to be now. We have reduced international exposure and increased the level of dividends in the portfolio. We are not just buying utilities and telecom issues; even tech stocks like Intel and Paychex have good yields.”
But he sums up: “We are at the point where the government drives interest rates so low that savers get nothing and governments get to borrow for almost free. Governments are inflating away debt at the expense of investors.” That’s one reason that when his firm buys bonds, it keeps the maturities short. He fears inflation. Summing up all these factors, says Hokanson, “We are not at the beginning of a new bull market” in stocks.
We have a looming apocalypse, and central banks are creating oceans of money to thwart it. So stocks and bonds do surprisingly well. But suppose the apocalypse comes?