Dollars and Sense: What's spurring the market's bull run?

Markets continue skyward. On Thursday, the last day the markets were open before the Independence Day holiday, the Dow finished above 17,000 for the first time ever. The S&P 500 also hit a new all-time high, and has now had its longest streak of quarterly gains since 1998, during the height of the stock market boom. The NASDAQ hit a 14-year high, now coming back within sight of levels we saw at the peak of the tech boom of the early 2000s.

Should we care? But do these milestone numbers really mean anything? After all, they’re just arbitrary numbers, and when the Dow is at 16,000, getting to 17,000 isn’t as big a percentage jump as getting from 6,000 to 7,000. The numbers are meaningful in that they tend to attract the attention of people who don’t follow the markets every day. They’re also a bit of a milestone for people who invest in the markets, an indicator that validates that decision—a confidence builder, you might say.

Why the run-up? Some of the reasons for this bull run are good and some are not-so-good. On the positive side, the economy is actually getting better. Critics of the Obama administration charge that it should have recovered more quickly. But no objective observer can say things aren’t better today than two or four years ago. The jobs picture continues to improve, and when more people are working, they’re making and spending more money. Those new jobs are a sign the economy is growing. The jobs report on Thursday indicated the economy added 288,000 jobs in June, and the unemployment rate fell to 6.1 percent. Those are both important and positive indicators. The research firm Markit said a survey of U.S. manufacturing posted the highest reading of its index since May 2010. A separate report showed manufacturing in China grew, calming fears of a slowdown there. The National Association of Realtors reported existing home sales rose 6.1 percent in May, over the April number.

On the other hand. But all is not sweetness and light. The Federal Reserve continues to pump money into the economy. That rate has slowed to $35 billion per month, but it is still a meaningful amount. And the total number keeps mounting. Lots of economists say these Quantitative Easing initiatives cannot help but lead to inflation, even hyper-inflation, some fear. Inflation at the consumer level seems to be in check, though we did get reports in the past couple of weeks that consumer prices are creeping back up. Where we have seen inflation is in assets, including the stock market. Lots of economists and analysts I’ve spoken with in the past year think the price of assets—including stocks but also land, housing, metals, and other assets—are artificially high, driven up by the Fed printing money and then pouring that money into the capital markets.

A day of reckoning? If stock prices are inflated, you should see that in the price-to-earnings ratio. Starting next week we’ll move back into a quarterly earnings cycle, so we’ll see if 2nd quarter earnings can keep pace with stock prices. So far, the market’s price-to-earnings ratio has been in line with historical norms. But it’s important to note that historically the price-to-earnings ratio has ranged from less than 5 to nearly 150 during the financial crisis, when earnings for the market as a whole approached zero. Since 2010, the PE ratio has been on the rise, from less than 15 to the current level of close to 20. Earnings season starts within a week, and if we see earnings growth, we could see prices stay where they are or even rise. But stocks have risen so high and so fast that—if history is any guide—we’ll see some sort of a market correction at some point. And when the market is above 17,000, even a 5 percent correction is going to feel like a jolt. A 10 or 15 percent correction, which is more typical of stock corrections … buckle your seat belts if that happens.

The week ahead. Aside from earnings season, it will be a pretty light week for economic reports. Alcoa, the company that traditionally kicks off earnings season, releases tomorrow, but this week we’ll see more of a trickle than a flood of reports. Lots of traders are on vacation, so it should be a pretty light week in volume, as well.