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Optimism returns to markets

Prospects for 2006 and hopes for steady interest rates pushed the Dow above 11,000 Monday.

By Ron SchererStaff writer of The Christian Science Monitor / January 11, 2006


The stock market, often considered a barometer of how investors feel about the economy's prospects, is now reflecting an optimism not seen in years.

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The main catalyst for the surge is the expectation that the Federal Reserve is close to its last interest-rate hike, which could make stocks more competitive than bonds. At the same time, the real estate market is slowing. Many Americans had moved assets there after the dotcom bust, but now, stocks are beginning to entice some back.

In more good news for investors, analysts expect the economy to run at a moderate pace without inflationary stresses and strains.

"It looks like we're back to the Goldilocks economy: It's not too hot, not too cold," says Alec Young, a market strategist at Standard & Poor's in New York. "The stock market hasn't looked this good in a long time."

The optimism has carried the Dow Jones Industrial Average past 11,000 for the first time since June 7, 2001. On Monday, the Dow closed at 11,011.90. The rally actually started in October, when some investors began to anticipate that the Fed would stop raising interest rates this year. Since then, the Dow has risen about 750 points.

The last time it closed at this level, investors had pushed up the price of Enron stock to more than $50 a share. And neighbors bragged about how much their mutual funds had gone up - not how much they made flipping condos in Miami.

The underpinnings of the stock market were quite different. Earnings are now about 50 percent higher than they were in June 2001. Dividends are 40 percent higher. And the stock market's valuation, based on its future earnings prospects, has considerably less fluff in it.

"This market looks better at 11,000 than the market did in 2001 when it was at this level," says Jeff Kleintop, chief investment strategist at PNC Advisors in Philadelphia. "Overall for the market, earnings are strong and valuations and balance sheets healthier."

Cautions on exuberance

Of course, investors have to be prepared that the stock market - or those guiding it - change course. "Things may not be as rosy as we are made to believe," says Axel Merk, manager of the Merk Hard Currency Fund in Palo Alto, Calif. "Some of the retailers didn't have such a great season, and there are doubts about their earnings. Oil is once again over $60 a barrel, and the Fed may not be done tightening."

Mr. Merk points out that so far, all the Fed has done is "talk." In releasing last Tuesday the minutes of its Dec. 13 meeting, the Federal Reserve indicated that most members of the committee that sets interest rates felt "the number of additional firming steps required would probably not be large."

Immediately after the release of the minutes, the stock market raced higher.

Merk, who mainly invests in gold and currencies other than the dollar, says, "I'm not sure everyone read the entire statement. It includes words like vibrant and brisk, words not usually associated with the end of tightening."

However, Mr. Young says the Fed's statement "is as close as you can get to an admission that there is light at the end of the tunnel."