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What's keeping the stock market aloft?

September 26, 2013

| MoneyRates.com Senior Financial Analyst, CFA

By mid-September, the S&P 500 was flirting with the 1,700 level, having gained nearly 20 percent so far in 2013. For the millions of people who own stocks in mutual funds, 401(k)s, and individual portfolios, a soaring stock market is always exciting. There's just one question that needs to be asked as the stock market reaches new heights: What exactly is keeping it aloft?

Here is a look at five possible reasons for the strong performance of stocks so far in 2013.

  1. Improving economy. A strong stock market is generally associated with a healthy economy, and the U.S. economy has shown signs of progress in 2013. After the real growth rate of the U.S. Gross Domestic product ground almost to a halt in the last quarter of 2012, real GDP growth has improved to 1.1 percent in the first quarter of 2013, and 2.5 percent in the second quarter. The problem is, those are still not very strong growth rates, and the weakening employment trend of late does not bode well for growth in the second half of the year.
  2. Earnings growth. The S&P 500 had year-over-year earnings growth of 15 percent through mid-year, which would seem to justify a double-digit growth price rise. The problem is, operating growth was up a much more anemic 3.6 percent over the same period, meaning that the impressive growth of reported earnings was more a function of accounting decisions than sustainable business conditions.
  3. Low interest rates. Savings account rates are still near zero, and bond yields are not much better than the S&P 500's dividend yield of about 2 percent. So, it's natural that investors would gravitate towards stocks as an alternative to weak bank rates and bond yields. Still, the lack of a better alternative is hardly the most inspiring reason for investing in stocks.
  4. Fed policy. Of course, those low interest rates are largely a function of Federal Reserve monetary policy, which has been attempting to jump-start the economy for nearly five years now. The stock market rallied on September 16 when the news broke that Lawrence Summers had withdrawn his name from consideration for Federal Reserve chairman. This means that Fed insider Janet Yellen is Ben Bernanke's likely successor, and the markets take the likely appointment of someone so closely aligned with current policies as a sign that those policies will continue. Still, the very basis for the Fed's low interest rate approach is that the economy is weak, and economic weakness does not make a very compelling case for stocks in the long run.
  5. Momentum. Stocks are unlike most things that are bought and sold. Usually, people find things more attractive when they are on sale. Stocks, on the other hand, get more attractive to people the higher their prices go. Eventually though, this is how bubbles are created.

To some extent, all of the above are partial explanations for the stock market's strong performance in 2013. The problem is, unless the first two become stronger forces in driving the stock market, that performance is more or less dependent on the perception of stocks being the best of a weak group of investment alternatives.

Perception can influence markets in the near term, but it will take more than just perception to sustain the rally over the long run.

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