Defying the doubters, stocks keep climbing higher, extending a rally that has lasted more than a year. On Mar. 29, the Dow Jones industrial average and the Standard & Poor's 500-stock index both traded at their highest points since Sept. 26, 2008.
All good things must come to an end, though, so investing pros naturally wonder how long the market can keep up its winning streak. The market hit its 18-month high in the face of widespread skepticism among both investors and the American public.
Most individual retail investors have not been participating in the rally. According to Morningstar (MORN), investors pulled $3.7 billion out of U.S. stock funds in February, the fifth month of outflows in the last six months. A Mar. 25 survey by the American Association of Individual Investors showed 34.7% of respondents are bearish, which is more than the 32.4% who are bullish and up from a 23% bearish reading at the end of 2009.
Many Americans seem unaware of the stock market's success and gloomy about the economy, according to a Bloomberg National Poll released Mar. 24. The broad S&P 500 rose 72.4% from Mar. 9, 2009, to Mar. 26, 2010. Yet the Bloomberg poll found only 31% of American investors said the value of their investments had improved in the past year. By contrast, 22% believe their investments' value has held steady and 46% believe their value has fallen.
Such pessimism is not necessarily a bad sign for the market's rally. Richard Sparks, who monitors the market mood as an equities analyst at Schaeffer's Investment Research, notes gloomy investors are often a positive sign for the market, indicating many stock sellers could be turned into buyers as the rally continues. Stock rallies often end when investors get "euphoric," Sparks says. "We're nowhere near that."
"We're beginning to see individual [investors] begin to put their foot back in the water," says John Wilson, chief technical strategist for Morgan Keegan. "I don't think we've seen a shift yet in the public's appetite for risk."
Investing experts point to solid foundations for the stock rebound. S&P 500 earnings were up 98% last quarter, 5.4% more than analysts predicted, according to Bloomberg. The latest corporate news to bolster market confidence was Oracle's (ORCL) forecast on Mar. 26 that growth of software license sales could return to 2008's pace.
"The characteristic phrase of this entire advance has been 'better than expected,' " says John Merrill, chief investment officer at Tanglewood Wealth Management. "Corporations and the U.S. economy continue to do better than expected."
The U.S. gross domestic product surged 5.6% last quarter.
Yet there are reasons to be cautious.
David Bianco, chief equity strategist at Bank of America Merrill Lynch (BAC), warned a sharp rise in long-term interest rates is "the major risk to this rally." Higher rates slow economic growth and make bonds a more attractive alternative to stocks. The 10-year Treasury currently yields 3.87%, but a "quick surge to 4.25% would stall the rally, and 4.5% or higher in the very near-term could cause a 10% correction," he wrote Mar. 26.
Stock strategists who rely on technical analysis argue the market has natural limits: After big advances, stocks naturally must take a break.
Quincy Krosby, Prudential Financial (PRU) market strategist, sees several reasons equities could continue to do well. The market for initial public offerings is "coming back to life." Financial stocks are leading the market higher, a good gauge of how investors view the overall economy. Despite high unemployment, consumers continue to spend at a modest rate. And, she says, relatively few companies have warned about weak profits this quarter, "suggesting that earnings will be more solid than current estimates."
However, Krosby warns, technical factors could limit the stock market's upside in the near term. After a strong run, "we're going to reach a resistance [level] that is going to be hard for the market to cross over," she says, pegging the level at about 1,180 for the S&P 500.
Economic data will continue to improve this year, says BTIG Chief Market Strategist Mike O'Rourke, but much of that expected improvement is already reflected in stock prices. "The equity market will do O.K.," he says, "but the gains may seem muted relative to [the growth in] the economy."
The market rally seems to have been powered by better-than-expected improvements in economic and business conditions. Whenever this fuel runs out, the rally could end as abruptly as it began.
Steverman is a reporter for Bloomberg BusinessWeek's Finance channel.
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