COLUMN-Nine reasons to smile about the stock market

Mon Feb 25, 2013 4:18pm EST

By John Wasik

CHICAGO Feb 25 (Reuters) - Over the past few months, it has been much easier to make a case that widespread financial anxiety is easing, although trying to quantify the upsurge can be like trying to catch a frog. As soon as you grab for it, it jumps.

At the beginning of last year, investors were grouchy about nearly everything and kept putting money into bond funds, while the stock market slipped. Then numerous economic indicators started pointing north and sour global financial news became less prevalent, and the tide turned as money started flowing out of bonds and into stocks.

As financial anxiety eases, investors feel they can take more risk and worry less about the worst-case scenario. This is good news for the overall economic picture in the United States.

While there are sure to be bumps in coming months, the prevailing trend is for a sluggish recovery in the United States and abroad and the current stock rally - the S&P 500 index is up more than 6 percent year to date through Feb. 22 - might continue to be bolstered by the Fed's easing policy.

For sure, it seems brighter days lie ahead and here is why:

* The tide seems to be turning on the major fears: The euro zone probably won't collapse, the U.S. is continuing to rebound and hyperinflation is not around the corner. Meager inflation and interest rates combined with less global anxiety will give legs to the current stock rally. It's as if the mass psychology of pessimism has turned a corner.

* Although the U.S. economy is not adding enough jobs to fuel a robust recovery, that is still a positive for stocks since it means the Federal Reserve will keep its quantitative easing policy in place in some form. Interest rates held at nearly zero translate into low financing costs for nearly every company.

While low interest is still a losing game for savers in search of yields, those willing to take more risk will return to the stock market and find it there. Just keep in mind that once the jobless rate reaches 6.5 percent, the Fed might change its mind and raise rates. But that doesn't appear on anybody's radar screen at the moment.

* Consumer optimism is also building, although it is more like a slow dripping faucet than a geyser. According to the National Association of Business Economists (NABE) outlook released on Monday, consumer spending is forecast to rise to 2.4 percent next year from just under 2 percent this year.

* Business spending is turning around. Companies spend money when they sense an improving economic climate. A Thomson Reuters survey released on Friday found that spending plans by S&P 500 companies are exceeding analyst estimates. That translates into more capital expenditures and hiring.

* The U.S. real estate market continues to mend. Even more important in the NABE forecast is its forecast that residential investment is expected to grow nearly 15 percent over the next year along with higher home prices and housing starts. That will stoke the wealth effect as homeowners feel more of a cushion from real estate and invest more discretionary income in stocks.

* Low inflation - and the diminished expectation of hyper-inflation - also plays well on Wall Street. One signal that inflation angst is easing is the price of gold and investors who trade in it. Money management company PIMCO, the world's largest bond-fund manager; and leading hedge-fund managers George Soros and Julian Robertson all reduced their stakes in the SPDR Gold Shares ETF, the largest exchange-traded fund that holds pure bullion, according to regulatory filings.

All of this signals that these influential investors are perhaps less worried about the financial climate in the West and inflation in particular. Since the SPDR ETF is a direct investor in gold, it is one of my favorite proxy anxiety indexes. When its price rises, it is a sign of skittishness about economic health, the dollar's value and inflation. When it drops, it shows that nervousness is abating.

* Money flowing out of gold probably is not heading into bond funds. Sanguine investors are more at ease with higher stock risk premiums. In the past year, the SPDR fund has dropped nearly 5 percent (through Jan. 30), with losses in the past one and three months. Its volume on Feb. 20 was more than six times what it was Nov. 20 of last year, so there a lot of dollars moving in and out of the fund.

Bullion prices have been steadily falling since last October. During the same period that gold has been declining in value, U.S. stocks have been on a steady rise. The SPDR S&P 500 ETF, which tracks the largest American stocks, has gained 16.5 percent year-to-date through Jan. 30. When investors are optimistic, that is a sign that overall anxiety has possibly dropped.

* Investors are generally upbeat. While overall consumer confidence is not entirely robust, according to the Conference Board and Rasmussen Indexes, investors are still favoring the stock market. A one-year stock confidence index tracked by the Yale School of Management's International Center for Finance shows that some 72 percent of individuals and institutions think the stock market will rise in the coming year.

* Stocks might not be over valued. The CAPE index prepared by Yale professor Robert Shiller, which shows a "cyclically adjusted price-earnings" ratio reflecting inflation-adjusted earnings from the previous decade, indicates an above-average valuation for stocks, although they are not anywhere near where they were in 2000, just before the dot-com crash. The CAPE ratio is currently at 23 and the average is 16.46. In 2000, the index was at 44, when stocks were incredibly over valued. While stocks are certainly getting pricier, they do not appear to be irrationally over valued.

One caveat is what happens with the U.S. budget sequester, which will trigger some $85 billion in federal spending cuts, beginning on March 1. If it is not resolved soon, the budget cuts might roil the U.S. economy and markets.

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