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Economic expansion: The economic expansion that began 44 months ago in June 2009 is still relatively young. The previous three expansions lasted 73, 120 and 92 months. And this one may finally be getting traction: Sales of new homes in January hit the highest rate in 4 1/2 years. Home prices in January were up nearly 10 percent nationwide from a year earlier. And sales of autos, the second-biggest consumer purchase, reached a five-year high. Stocks still seem reasonably priced based on the earnings that companies are generating. On average, stock prices are 17.5 times per-share earnings in 2012 versus 19.4 times in 2007. Today's price-earnings ratio is the same as the average since World War II. Of course, if investing was as simple as looking up interest rates and stock valuations, we'd all be rich. Plenty can go wrong. For starters, future earnings, the biggest driver of stock prices, could prove disappointing. Financial analysts expect earnings for the S&P 500 to grow a healthy 8 percent this year, according to FactSet, a provider of financial data. Most of that increase is expected in the last half when they assume economic growth accelerates. Will that happen? It's anyone's guess, and financial analysts are often too bullish. A year ago, they expected a 13 percent jump in earnings in the last three months of 2012. They got 4 percent instead. Investors also need to pay attention to what's happening in the rest of the world. Big U.S. companies generate nearly half their revenue from overseas. The 17 European countries that use the euro as a currency have been in recession for more than a year. Japan, the world's third-largest economy, fell into one late last year. Stock markets tend to look ahead, so what matters is whether the recessions deepen in Europe and Japan or those economies start growing again. Another worry is what will happen after the Federal Reserve stops stimulating the U.S. economy. Last month, minutes of the Fed's last policy meeting were released, and they showed members disagreeing on when to stop. The Dow lost 155 points in two days. Jeff Sica, founder of money manager Sica Wealth Management, says the rising market is good because it's a sign of confidence. But he fears stocks could sink when the Fed stops buying bonds. It's a big "psychological reason the market is going up," he says. "People know the Fed will continue to inflate assets." The Fed stimulus was in response to the worst economic recession since the 1930s. The Great Recession began in December 2007, two months after the Dow and S&P 500 reached their peaks in October. It was triggered by a drop in home prices that hammered consumers and banks. Nine months later, in September 2008, Lehman Brothers declared bankruptcy and lending froze worldwide. Panicked investors began pulling money out of stocks. Prices, which had been falling slowly, nosedived. By March 9, 2009, the Dow had fallen 54 percent and the S&P 500 57 percent. In total, $11 trillion in stock wealth, or 12 years of stock gains, was wiped out in 17 months.
Despite widespread fear then, the history of bear markets was encouraging. In the second- and third-worst bear markets since World War II, the S&P 500 fell 49 percent in 2000-02 and 48 percent in 1973-74. Both times the climb back took less than six years. But few people believed four years ago that the return would be so fast. A few days after stocks bottomed, a BusinessWeek cover story laid out three scenarios for regaining the losses. The most pessimistic held that stocks would notch 6 percent gains each year and the Dow would return to its old high in 2022, 13 years later. The most optimistic assumed 10 percent annual gains and saw a return in 2017, eight years later. The Dow has rebounded in about half the time as the most optimistic case. The climb hasn't been smooth, though. In May 2010, a trading glitch set off a so-called flash crash that sent the Dow plunging 600 points in five minutes. In August 2011, stocks yo-yoed for several days on fears that the U.S. would default on its debt. Over three weeks, the Dow plunged 2,000 points. Beginning last October, the Dow fell 1,000 points over six weeks on worries that a budget deal wouldn't get passed and the economy would go over the "fiscal cliff." But the Fed's bond buying and the ability of companies to produce record profits helped the market overcome every setback. In the turbulent journey to new highs, Wall Street strategists and other experts have predicted many times that small investors were about to fall in love again with stocks. The "dry powder" of their money would set fire to an already hot market. After all, small investors had helped push stocks up in the great bull market of the
'80s, which began in August 1982. Those who had left the market years earlier began buying again, and stocks more than tripled in five years. They drove a bull market again in the 1990s. Stocks more than quintupled in 9 1/2 years. But small investors have not only stayed away the past four years, they have sold hundreds of billions of dollars of stocks. Then, in January, as the Dow inched closer to its record, individual investors seemed to have second thoughts. They put nearly $20 billion more into U.S. stock mutual funds than they took out in January, according to the Investment Company Institute, a trade group for funds. It was just a trickle, but it may have helped stocks surge. In January, the Dow rose 5.8 percent, and the S&P 500 rose 5 percent. It was the best start to a year for the Dow since 1994. For good or ill, it's possible the Dow's new high might convince investors to put more money into stocks. "When you hear about new highs, the greed factor kicks in," says Colas, the ConvergEx Group strategist. "It gets people to think,
'Do I own enough stocks?'"
Most important, hiring is picking up. Employers added an average 200,000 jobs each month from November-January, compared with 150,000 in each of the prior three months. More jobs means more money for people to spend, and consumer spending drives 70 percent of economic activity.
If per-share earnings keep growing, stock prices could go up too, and the P/E ratio would stay the same. And there have been many periods in which P/E ratios rose well above the long-term average. Such "multiple expansion," as market watchers refer to a rising P/E ratio, would mean stock prices would be even higher.
To stock bulls, the economy is on the verge of what Bernanke calls "escape velocity," a self-sustaining pace of growth and better than the sluggish 1-2.5 percent of the past three years. Faster economic growth would boost corporate earnings, which would lead to higher stock prices.
[Associated
Press;
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