Why stocks may keep a rosy view


If only the economy were as easy to fix as the stock market.

Share prices have surged since early March with only a few modest interruptions. You’ve either been long or you’ve been wrong.

But since mid-October, fresh doubts about the economy have helped to trip the U.S. market and many foreign equity markets.

Now, for the umpteenth time, investors hear warnings that stocks are vulnerable to a steep pullback.


Well, maybe. But there is just as good a chance that the seeming disconnect between the market and the real economy will continue.

Times still are hard out there for workers, but corporate America overall has been managing remarkably well -- as reflected in share prices.

Many companies, for example, have benefited from investors’ robust appetite for bonds this year as credit markets have loosened. As long-term interest rates have dived, investors have rushed to lock in yields on fixed-income securities.

That has allowed companies to refinance older debt at lower rates, reducing their interest costs. The bond market has been so welcoming, in fact, that Standard & Poor’s this month slashed its estimate of the percentage of “junk"-rated firms that are likely to default on their debt in the next 12 months, to 6.9% from a prior estimate of 13.9%.

As stocks have climbed, investors also have warmed to new share offerings, providing another source of funds for companies hoping to bolster their balance sheets.

Westlake Village-based Dole Food Co. was able to go public on Oct. 22, selling 35.7 million shares at $12.50 each. Its investors may be having buyer’s remorse, with the stock at $11.74 on Friday. But that doesn’t matter to Dole at the moment: The $446 million the firm raised allowed it to pay off a chunk of debt, boosting its credit rating.

Probably the most important element of support for stock prices since this spring has been corporate earnings reports. Though many companies still earned less than they did a year earlier, before the economy crumbled, results have handily beaten investors’ expectations.

Of the 344 companies in the Standard & Poor’s 500 index that have reported third-quarter results to date, 80% have exceeded analysts’ estimates, according to Thomson Reuters.

This is a game that Wall Street likes to play, of course: Analysts set the bar low with their earnings estimates and companies top them. Surprise! Stocks jump.

Even so, the better-than-expected results suggest that investors had underestimated the extent to which this year’s massive wave of corporate cost-cutting -- particularly job cuts -- would benefit the bottom line, despite a lack of revenue growth.

And what have companies done with the money they’ve saved? In many cases, nothing: It’s sitting on their books.

Industrial firms in the S&P; 500 index (that’s a subset that includes most of the index’s companies, excluding financial-services firms) had a record $773 billion in cash on their balance sheets as of June 30, up from $648 billion a year earlier, S&P; estimates.

“They’re still hoarding money,” said Howard Silverblatt, a senior analyst at S&P.;

Jobless Americans, understandably, would prefer to see some of that cash spent on hiring. But we know from government data on employment that many companies either continue to shed workers or remain reluctant to add staff, even amid signs that the recession is over.

Allen Sinai, head of Decision Economics Inc. in New York, believes that corporate managers may be surprised at how well their companies are faring even after deep reductions in head count.

“They’re making good money without people,” Sinai said, in what may be only a modest overstatement.

It’s also likely that many major companies, if they’re hiring, are doing so overseas. Not only is labor less expensive in most countries outside the U.S., but economic growth prospects also are more appealing overseas, especially in emerging-market countries.

You can’t argue with that logic, but it doesn’t make the U.S. economy’s struggle any easier to abide.

Next Friday, when the government reports on October employment, it’s possible that the jobless rate will jump to 10% from 9.8% in September. Double-digit unemployment would be a stark reminder of how long the economy’s recovery process could take.

Next Tuesday and Wednesday, Federal Reserve policymakers will meet. No one expects the Fed to raise short-term interest rates, but there has been debate on Wall Street about whether the central bank will hint more strongly that higher rates are somewhere on the horizon.

The focus is on the language the Fed has used in its post-meeting statements this year, citing the need to keep rates “exceptionally low . . . for an extended period.”

Policymakers could signal their faith in a recovery by eliminating the reference to “an extended period.”

But many economists wonder why the Fed would risk spooking financial markets by suggesting that a rate hike might happen sooner rather than later, in the absence of inflation pressures.

On Thursday, the government’s report on third-quarter gross domestic product estimated that the economy expanded at a 3.5% real annualized rate in the period, heralding the unofficial end of the recession. Yet it was clear from the report that the rebound was largely a factor of federal stimulus, including the “cash for clunkers” program that boosted auto sales.

As long there are doubts that the economy’s recovery can be self-sustaining, it makes no sense for the Fed to talk about tighter credit. And as long as the Fed supports financial markets with near-zero short-term interest rates, investors have more reason to believe that a self-sustaining recovery will take hold.

That doesn’t mean that stocks can’t pull back after their stunning run-up since March. Maybe we’ll even get the long-awaited 10% to 15% “correction” in blue-chip share prices.

But the corporate world’s resilience this year strongly argues against another market calamity. What we need is for that resilience to translate into something good for the real economy.