Newspaper article Sarasota Herald Tribune

What to Do When Stocks Act Differently from the Economy

Newspaper article Sarasota Herald Tribune

What to Do When Stocks Act Differently from the Economy

Article excerpt

THE STOCK MARKET HAS BEEN on a tear most of the last 18 months; the global economy not so much. While many investors have buckled up and enjoyed the market's wild ride, this disconnect has caused thoughtful investors a great deal of consternation.

The critical questions are: What is causing this disconnect between the stock market and the real economy? Is it likely to continue through the rest of 2013 and into 2014?

It's clear to me and many others that this dichotomy has to end and relatively soon. This can happen in several ways: The economy can continue to grow at its torpid 2 percent rate and the stock market can slow down to a low single digit annualized growth rate. The economy can accelerate and grow at a 3 to 4 percent rate and the stock market can slow down to a higher single-digit annualized growth-rate. In either case, there is zero probability that the stock market can continue on the course investors' have seen for the last 18 months.

Why does the divide have to narrow?

The quick answer is that securities markets ultimately reflect the economy. While the underpinnings of the following are technical, these two guidelines relating the economy to the securities markets are generally accepted.

Longer-term, earnings won't grow much faster than the economy.

Longer-term, the total return from the stock market will track annual dividends plus the growth in earnings-per-share.

Thus, the key to understanding what will likely happen in the stock market is to understand what will likely happen in the global economy.

We can start by answering the first question at the beginning of the column. It's generally accepted that the divide between the behavior of the real economy and stock market is caused primarily by the U.S. Federal Reserve and other central banks flooding the markets with cash and holding interest-rates at historically low levels. This has forced many investors to move their investments further out on the risk curve from safe CD's to stocks.

It's now certain the Federal Reserve and perhaps other central banks will begin to throttle back on stimulus sometime in the next 12 months. This will be a double dilemma for the stock market. …

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