Reply #4: If Economy's So Strong, What's Wrong With Stocks? [View All]

[RawMaterials]

http://quote.bloomberg.com/apps/news?pid=10000039&cid=currier&sid=a9zJGAAZN1N0

Jan. 21 (Bloomberg) -- Solid economic news in the early days of 2005 hasn't done much for a shaky stock market.

U.S. growth starts the year looking stronger than expected, without stirring up a big increase in inflation or higher long- term interest rates.

As in 1987 and again several times in the 1990s, the stock market decline of the early 2000s failed to usher in any sustained economic slump.

snip..

Slim Spreads

In some ways, the markets have responded with alacrity to the economy's vigor. For example, the extra yield investors demand to own low-rated ``junk'' bonds by comparison with U.S. government bonds has lately shrunk to about 3.2 percentage points, the narrowest yield spread since 1998.

snip..

And in stocks? On average, the stocks that make up the Standard & Poor's 500 Index trade at about 20 times their earnings for the latest 12 months. That's pretty generous, given that a ``normal'' P-E was once considered to be about 15-to-1.

Paying the Price

Yet it's well below the monthly average for the last 10 years, which according to my Bloomberg works out to 27 to one. While everybody agrees the index was outrageously high at the end of the 1990s, it has spent the last five years doing penance. From the end of 1999 through the end of 2004, it lost ground at the rate of 2.3 percent a year.

Fresh memories of the severe 2000-02 bear market by themselves serve as one damper on investors' spirits. The terrorist attacks of Sept. 11, 2001, also left a stark mental and emotional impression that is very slow to fade.

The South Asia tsunami of late December 2004 only reinforces images of the modern world as a place of great and unpredictable danger.
Maybe the biggest financial worry of all is the possibility of some economic dislocation resulting from trade and budget imbalances, or currency instability -- in Geithner's words, ``the risk of unanticipated shocks to financial prices.''

Prudence

``The probability of these shocks may be low,'' he said in his Jan. 13 speech. ``But it is higher than it has been, and higher than we should be comfortable with.''

If the worst happens, better for all concerned if they were on their toes. If the worst doesn't happen, the present cautiousness toward stocks leaves some room for future market gains.