The Real Reason You Should Be Bullish On Stocks

People like to think of free markets as being just that – free from external influence. I’m not approaching this as a hysterical conspiracy theorist predicting the demise of all fiat currencies and a gold standard, but from a pragmatic (and now proven) political/impact assessment standpoint. The reality is, the stock market was not allowed to fail for reasons that should have been completely obvious at the time, but are now being proven with both actions and historical returns. I’m glad I stayed 100% long equities, but in retrospect, I should have begged borrowed and stole (OK, not stole, but margin, options and other leverage) to further partake in an unprecedented 100% return of major indices in a 2 years period.

How Governments Forced Markets Higher

Governments globally cooperated (or conspired depending on which word you choose) to pump markets full of liquidity, backstop failures in large institutions and even EU member states with guarantees and essentially prevent further declines in equities. We saw the US try to forestall declines in housing with Trillions of dollars in bailouts, Fannie/Freddie guarantees, mortgage modification programs, zero interest rates, cash for clunkers, and even the 2011 energy tax credit which was partially extended from the 2009-2010 program. While the net benefit of many of these programs is questionable at best, the actual impact was to essentially pull forward Billions in spending in exchange for a increased debt servicing burdens down the road. Essentially, over the past 2 years, consumer spending has been artificially stoked in epic proportions, thus boosting equity returns the likes of which we’ve never seen.

Why Governments MUST Continue to Force Stocks Higher

So much for free markets. As much as I question valuations, fundamentals and future debt problems for the economy at large, governments will continue to force equities higher. The reason is the stakes are too high to let them fall. See, Trillions of dollars in pension plans, retirement plans, state and municipal budgets, not to mention wealthy investors – all have a lot riding on equities returns. With virtually every state’s pension plans underfunded, rather than fessing up and increasing taxes or cutting spending, they’ve simply resorted to boosting their projected annual returns in some cases to 8.5% or higher. After a 100% runup in equities, reasonable investors in a vacuum shouldn’t expect 8.5% per year in the near term, but that’s what states and municipalities are projecting. Furthermore, as TARP and other government guarantee programs come into the black as equity prices increase, it makes the bailout history appear to be more palatable (and thus, set the stage for future bailouts). After all, if we lost Billions on the bank loans, during the next financial crisis, it would be difficult to shell out that kind of money again. But at the moment, we’re showing break-even and even profits for various facets of the bailouts due to skyrocketing equity prices. So, next time a Too Big to Fail bank is ready to fold, politicians can now look back and point to the profit the Treasury realized last time around.

So I’m not a permabull citing natural reasons equities should climb from here. I’m a reluctant participant along for the ride, finally accepting of the role our government has taken on in forcing equities higher at least for the next year to two. I do believe our reckless debt burden will eventually come home to roost and by the time it’s reflected in higher interest rates it will be too late to course correct. But that is now likely years off – which will make it even more dire when the time comes. But with an election year coming up for Obama, you can be sure there will be even more efforts, either overt or covert – to continue to push equities higher. Voters’ retirement accounts, state budgets and pension plans are counting on it!

What Are Your Thoughts?

This has been a guest post by Darwin. He is an engineer and MBA who takes an “evolutionary” approach to finance, writing about adapting to evolving financial management, tax, investing, and savings opportunities. Making more money and saving more money is an adaptive process – join the evolution! He blogs at Darwin’s Money and ETF Base.

Comments

  1. says

    Your post makes plenty of sense. The problem that I see today is that you have two options:
    1. Lose to inflation
    2. Become a reluctant participant and lose to terrible market swings

    In the end you have to pick something, and I’ve decided if I’m going to lose I might as well gamble.

    -Ravi Gupta

  2. says

    You make some really good obsevations with excellent analysis of the governments role in artificially stimulating equity markets. I agree with your analysis, but I believe your investment positions are dangerous. First of all you are assuming the government will continue its expansionary fiscal and monetary policies. Second, even if you are correct, you may be partcipating in another equity bubble.
    It is possible we are headed into an era of austerity where the government actually cuts the budget (maybe I’m naive too!) It’s also possible the Federal Reserve will not be able to continue its extreme expansionary monetary policies.
    I any event, investing should involve paying attention to value and valuatons are now at levels that history tells us will produce low or negative returns over the next few years. That means asset allocation and selective stock selection will continue to be crucial to successful investing.
    Thank you.

    • says

      Hi Ken,
      Yes, a wildly optimistic outlook could be dangerous for many investors. In my case, I’m in my 30s and have a 30+ year time horizon until drawdown for retirement is even pluasible. Next, my risk tolerance is quite high. Finally, in 401K account at least, it’s stocks or bonds – and I think bonds are even more richly priced than stocks. At least in an inflationary environment, we can see dividend increases and earnings increases (we’re hitting an all-time record on earnings for the S&P500 this year btw while P/Es are half what they were during bubble in 2000) drive equities higher whereas inflation kills fixed income investments.

      Conversely, I did recently do a post on how we are actually at a higher historical P/E and reversion to the mean could spell a decade of flat to negative returns for equities if history is any barometer.

      So, I did caution that a few years out, this will come home to roost, but in the near term and of course 20/20 looking back, it’s been the best game in town! (aside from silver perhaps if I had that foresight).

  3. says

    Interesting analysis. You are however looking backwards with perfect hindsight. It could have been very possible that instead of taking off after 3/9/09 the market could have wandered listlessly for 12 to 14 months or so. Maybe they let AIG go under rather than Lehman. Maybe the toxic debt they bought was worse than they thought. After the fact it always seems like those in charge knew what they were doing but when the true history is written we’ll see they didn’t.
    Today we have municipalities in trouble, 3 wars going on, a political system that is dysfunctional, valuations that are historically high, and a Fed that is ending the QE2 that pushed stock prices higher. I for one don’t see investing in stocks as necessarily an easy play.

    • says

      DIY, I’d also add we’ve had a nuclear meltdown in Japan and the entire Middle East ruling structure is imploding… and stocks are still not correcting! It’s crazy, but I think it’s just indicative that money has nowhere else to go at this point. Bonds are way overvalued (munis at risk as you suggest) and savers can’t earn a dime in interest bearing accounts. Now that the financial system didn’t collapse, it’s been up up and away. I do think we’re deserving of a correction, and at least in my trading account, I have some hedges. But for long-term money, it’s all equities.

  4. Mike@javainvestor.com says

    While you may feel richer when assets go up in value the question is this a real gain or illusionary. In this article from Yahoo! (below), it makes the case that inflation is really close to 10% if one uses the same calculations as in the past.

    As a confirmation of this one need only look at gold/silver prices. Markets don’t lie like people do, so high gold prices demonstrate inflation. I agree with Darwin that government is in too deep. This is unfortunate because they control the money supply also. So, all the conservative objections to government involvement in health care, education, etc are now being confirmed.

    It’s not all bad news because those who own real assets (real estate, quality stocks, etc) will always win out regardless of monetary considerations.

Leave Your Comment

*