This has been a year inundated with a barrage of negative news. Whether it’s the disappointing news on the employment front or an international crisis, the stock market has managed to deliver positive performance.
For the first six months, the S&P 500, an index of 500 large company stocks, had a total return of 6%. In comparison, money market returns are still near 0%, and 10-year Treasuries are yielding only about 3%, or 1.5% for six months. This is impressive, given that the stock market has registered double-digit gains the past two years, and now has a decent chance for a third straight year of strong returns.
An obvious concern might be whether these returns in the stock market are justified. For the stock market to move higher, either the economic news is not as bad as it appears to be or business conditions are likely to improve. Looking deeper, the economy isn’t that bad and the second half of the year will see stronger economic growth.
Looking at the most recent employment report, which showed only 18,000 jobs being created in June, it would appear difficult to be optimistic. The day before, another employment report by the firm ADP showed 157,000 private sector jobs were created. For the stock market, expansion in the private sector is more important than government employment, in which 39,000 jobs were lost in June. In addition, tax collections by states, including California, is improving, which is a sign of a stronger economy. More important is corporate earnings, however, which have been expanding at a healthy pace and should remain strong with upcoming reports.
The stock market is forward looking and, ultimately, what drives prices will be whatever happens in the future. As parts shortages due to the Japanese earthquake and tsunami dissipate, manufacturing should once again accelerate. On the negative side, the government debt crisis in Europe is a significant issue and has the potential to be a problem for world markets. For now, I believe a major crisis in Europe will be averted but investors do need to monitor the situation.
The best course of action for investors is to maintain a normal allocation to stocks. Given all the negative news, it is certainly tempting to want to avoid stocks, but bank accounts and bonds are not very compelling alternatives currently. Of course, if someone has immediate cash needs, such as saving for a down payment on a house, I would not recommend investing in stocks or longer-term bonds. There will continue to be days that the stock market drops on disappointing news and global concerns, but a repeat of 2008 would be very unlikely.
