Global tensions don't dent enthusiasm for stocks

Published on NewsOK Modified: July 25, 2014 at 3:47 pm •  Published: July 25, 2014
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A war breaks out between Israel and Hamas. An airliner is shot out of the sky in Ukraine. A Portuguese bank's finances look shaky.

And the U.S. stock market's response? After dipping briefly on the bad news, it climbs higher.

The market's resilience this year — which has pushed it to a series of records and extended its five-year bull run — is driven by investors' optimism over the growth of the U.S. economy and record corporate earnings. That helped the market overcome its latest dip, on July 17th, when a passenger jet was shot down in eastern Ukraine and Israel invaded the Gaza Strip, raising investor worries that conflicts around the world could escalate and destabilize financial markets.

As they have all year, investors responded by using it as an opportunity to buy stocks. In fact, they've "bought on the dip" consistently for three years, keeping the market's slips from becoming slides. Stock pullbacks since 2011 have been rare and relatively small, and none have become severe enough to qualify as a correction, Wall Street parlance for a fall of 10 percent or more from a peak.

The lack of a correction for such a long period is unusual, because the Standard & Poor's 500 index experiences such a decline on average every 18 months, according to S&P Capital IQ research.

Many investors say that the uninterrupted rally is justified by the outlook for stocks. Central banks worldwide have policies in place aimed at stimulating economic growth, and U.S. corporate profits continue to rise, even in the first quarter, when the economy contracted.

That has driven the S&P 500 up 7 percent this year, not including reinvested dividends. That's on top of a 30 percent surge in 2013. The index closed Friday down 0.5 percent at 1,978.34, after closing at a record 1,987.98 a day earlier.

"The fundamental underpinnings of this bull market remain very much intact," says Katie Nixon, chief investment officer for wealth management at Northern Trust.

In the U.S., the Federal Reserve has held short-term interest rates at close to zero for almost five years, and has bought $3 trillion of bonds to hold down long-term rates. The Fed has been winding down its stimulus, but a rate increase isn't expected until at least 2015.

The European Central Bank in June introduced a raft of unusual measures meant to revive the eurozone economy by getting credit flowing to companies. Japan's central bank is also trying to stimulate that nation's economy.

While these policies have cut borrowing costs, they have also reduced the yields on bonds — and the income they generate for investors. As a result, investors have shifted their money to other assets, such as stocks, in the hunt for better income. That dynamic has supported the rally in stocks.

Utilities, which are regarded by some investors as a proxy for bonds because they are relatively stable and pay rich dividends, are the biggest gainers in the S&P 500 this year. Their dividend yield — which measures how much a company pays out in dividends each year compared with its stock price — stands at 3.5 percent. The yield on the 10-year government Treasury is 2.5 percent.

The stock market could suffer a sharp, but short, correction later this year once the Fed finishes withdrawing its stimulus and investors start to focus on when exactly the central bank will begin raising interest rates next year, says Robert Pavlik, chief market strategist at Banyan Partners.

"The market is going to focus more and more on when the Fed moves," said Pavlik. "That's the biggest chance for a correction to come at us."

But for now, investors are focused on company profits, and the outlook remains strong. Earnings for S&P 500 companies are expected to climb 7.8 percent in 2014, their fifth straight year of growth, helping investors overcome concerns about the Fed and rising political tensions.

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