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Stock Market Insight | Bob Williams

I was recently asked about the significance of the major market indexes breaking certain levels. With the Dow Jones Industrial Average breaking 13,000, the Standard and Poors 500 Index back above 1400 and the Nasdaq Composite Index closing over 3,000, do these figures really impact investor confidence? I think they do; albeit, from a purely psychological perspective. When the market is setting new highs on a regular basis, investors who are holding stocks tend to feel wealthier. If you are profiting from a rise in the indexes, you are much likelier to invest additional funds. No one likes to be left out.

Another factor impacting the market rise is retirement monies flowing into mutual funds. Once established, most retirement plan participants do not change their investment allocation during the year. In plain English, when you decide how you want your retirement monies invested when enrolling or electing to continue your participation in your 401(k) or other retirement plan, most folks don’t change that very often. If you are a long term investor, most likely you have been counseled that stocks are the place to put your money. And most retirement plans offer mutual funds to provide their participants with professional management and adequate diversification. But few investors know that bonuses for many managers of these mutual funds are based on their performance relative to the comparative benchmark. In other words, a large cap blue chip stock fund’s performance may be compared to the returns of the Standard and Poor 500 Index. If the fund outperforms the index, the manager’s annual bonus may be substantially higher than that of a manager whose performance lags. Managers quickly learn that it can be costly to keep too much cash in their fund and puts pressure on them to stay invested lest they miss an upward move in the market and underperform relative to their benchmark and their peers. As a result, these regular inflows of cash into stocks keeps a level of upward pressure on stock prices even during times of economic turmoil. I believe this theory has certainly been borne out in recent years.

With the global economy struggling, why are stocks this high? In my experience, financial markets react to relative expectations and not absolute numbers. As a result, the economic difficulties in the rest of the developed world are not necessarily bearish for the U.S. investor. While global demand and exports have been deeply affected, investments in U.S. stocks still look like the “best looking dog” in an otherwise ugly litter. It’s sad but true when we acknowledge that the statement “We’re less doomed than you.” is an accurate portrayal of the circumstances. Additionally, as of this writing, Bloomberg reports that 72% of companies reporting second quarter results so far have beaten analyst’s estimates; nonetheless, corporate revenues were dismal. The reality is that earnings are a function of cost control and are frequently the result of staff reductions and layoffs. Unemployment is high and likely understated.

What can we look forward to? There are real economic problems but the change is that investors are now aware of these issues and not being surprised by them. The European economic disaster and the decline of the housing market were not the subjects being discussed at cocktail parties before those markets crashed. Now they are. Those pontificating that we are currently in a recession need to wait for at least one negative Gross Domestic Product report. The rise in stock prices is due to level out but the bears must come up with something new to focus on lest they spend more time growling than eating.

To learn more, click here to listen to Bob’s interview with Roby Brock of Talk Business.

Bob Williams
Senior Vice President & Managing Director
Delta Trust Investments

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