The stock markets have finally recovered to levels not seen since the beginning of the beginning of the Great Recession in late 2007. The Dow Jones Industrial Average has gained 7,706.72 points from its March 9, 2009 low point to its new high on Tuesday.
But, the markets are very sensitive to both political and economic developments. So, the question all investors are asking is: Will the stock markets continue to rise? The gains are creating an enormous amount of wealth for all investors, ranging from the most sophisticated hedge fund managers to middle class workers in their pension funds.
But the risks to further gains are imposing and global in nature. Here are 6 of the largest issues aside from corporate earnings that could greatly influence stock prices in the coming months.
1. Federal Reserve easing. Currently, the Fed is buying billions of dollars of securities every month in an effort to increase the money supply and hold down interest rates. This strategy is sensible so long as inflation remains low and unemployment remains high. The Fed is hoping that the latter will decrease in about two years to an acceptable level, at which time Fed easing will subside. A continuing surplus of easy money will drive rates down to levels that are unsustainable in the long-term. Nevertheless, lower rates enable corporations and individuals to borrow money cheaply, which will encourage economic growth and improve housing prices. On the flip side, extremely low rates are wreaking havoc on income investors, such as retirees, who have no choice but to buy stocks in an effort to capture an acceptable yield on their savings.
2. The European crisis. Very large European countries are having difficult times getting their financial house in order. Excessive unemployment, disastrously low real estate prices, decades of catering to powerful unions, mismanagement, and corruption have resulted in an explosive situation across the pond. It would be irresponsible for the U.S. to minimize these events. A large default by Spain or Italy could suck the air out of the current market and have global repercussions. Also, Europe is a very large trading partner of the U.S. In a nutshell, the Europeans must find a balance between stimulus and austerity to move forward.
3. A new crisis in the financial industry. There are still too many “too big to fail” institutions in the world. On one hand, these organizations are the catalyst of growth and prosperity. On the other hand, they are in a risky business and dependent upon investor and creditor confidence, which can disappear rapidly. If a large financial institution incurs a significant setback (a large loss or defalcation), the entire global financial system could be threatened. In their haste to prevent another calamity, regulators are doing many things that discourage the success of financial companies such as banning certain profitable albeit risky activities and interfering with compensation arrangements. The world needs healthy, profitable banks to facilitate trade, which the stock markets monitor closely.
4. The U.S. government’s political crisis. The odds of a continuing global recovery are diminished if the greatest country in the world regularly assails businesses and the creation of wealth. The situation is exacerbated by an attitude that entitlement reform should be deferred and more social stimulus should be implemented. The U.S. has a festering debt problem. The country’s well-being and role as a financial safe haven could be jeopardized if the president and Congress keep kicking cans down the road. The solution to the unemployment problem is not class warfare, redistribution of wealth, or decreasing opportunities. Americans should not be wards of the state; they should be earning money and paying taxes. A radical change in our capitalistic system and a further expansion of social support will not improve our country.
5. Revolution, aggression, and weapons of mass destruction. Whether you want to accept it or not, there is a global effort by terrorists to destabilize many places in the world. The unseemly actions of provocateurs in the Middle East are making our world a more dangerous place every day. The global effort by radical religious groups can impact the economic future of all nations. Just consider the financial implications of 9/11. Controlling crazed jihadists and despots who want to develop nuclear weapons should be paramount. It is inconceivable that the greatest powers in the world have been unable to work together to combat growing political risk globally. Worldwide instability will negatively impact investment.
6. Long-term improvement in economic growth in all nations. The seeds of discontent grow more rapidly in places that are fraught with poverty, disease, and hopelessness. In the long-term, dangerous places will be less dangerous if the people prosper. Economic success results in more food, more medicine, better housing, and a better way of life. More money needs to be spent in places where people are unhappy because their lives are so difficult. This will ameliorate the tendency of the same people to revolt and kill. Continuing discontent will only serve to make worldwide markets more volatile and risk averse.
The world is connected politically and economically. The situation is very fragile, and an isolated incident in a far off place could evaporate trillions of savings in an instant. The U.S. must once again assume global leadership and co-opt other nations to focus on economic progress and less suffering. Our government must make our country stronger economically so we will be able to export technology and goodwill. An inability to do so will be more stock market uncertainty.