KEY POINTS:
By all accounts, the world's investors are uncommonly optimistic heading into 2007.
Reports and surveys of every description say the economy will keep growing, inflation and interest rates are in good shape - and stock prices are a sure bet to rise in the US and elsewhere for a fifth consecutive year.
"Money managers are bullish on stocks for 2007," says Russell Investment Group, which invests US$180 billion, reporting on its latest quarterly poll.
The survey found "the highest percentage ever" of managers who consider the market undervalued.
"We're going to continue on with the same trajectory of the past few years, a combination of relatively solid growth and low inflation," said John Lipsky, the second-ranking official at the International Monetary Fund.
Remember, though, this is economics, the notorious "dismal science", in which every silver lining has its cloud. Sure enough, the bright forecasts have already produced a backlash.
"Stock strategists raise alarms with unanimous call for a rally," said the headline on one recent story.
"Investor sentiment appears worrisomely bullish, suggesting a market correction may be needed," said the financial newsletter Dow Theory Forecasts.
Somebody must have hit the fast-forward button, taking us through a full cycle in market sentiment, from bullish to bearish, before the new year has even begun.
As any experienced investor knows, what's at work here is the time-honoured doctrine of contrary opinion, which reminds us that market prices are always prone to doing the opposite of whatever the majority expects.
If stock prices are going to rise, they need new buyers who have just been converted to the bullish cause. As Dow Theory Forecasts put it, "Once nearly everybody is convinced that stocks are headed higher, there is nobody left to buy."
After four consecutive years in which the Standard & Poor's 500 Index has risen an average of almost 15 per cent a year, it's clear that a significant amount of buying has already been done. Some insist, however, that the mood remains far short of the kind of "irrational exuberance" that Alan Greenspan, now retired as chairman of the Federal Reserve, worried about in the 1990s.
"One of the most intriguing aspects of this recovery has been its inability to inspire confidence," says Jim Paulsen of Wells Capital Management in Minneapolis. "Throughout this recovery, most players have been hunkered down waiting for the next terror attack, the next dotcom meltdown, the next financial blowout, the next hurricane, the next bird-flu pandemic, or for the imminent consumer collapse."
This wariness, Paulsen says, has helped keep reserves of loose money, or "liquidity", in ample supply. "What do worried economic players do? They hoard liquidity to be prepared for the rainy day they perceive is coming," he says. The current abundance of liquidity, all agree, is a global phenomenon. As it works its way through booming emerging-market economies such as China, it has helped produce heavy demand for dollar-denominated US securities such as Treasury bonds. Booms are good, right? Doubly so if they translate into investment flows that help keep interest rates low. But of course, there is a contrarian side to this story too.
If the dollar should turn weak in the world's currency markets, the flood of worldwide liquidity could quickly start to dry up. Said Lipsky: "Policies need to be put in place in the US and in the rest of the world that will make global growth less dependent on US spending and more dependent on a balanced global growth."
The continued rise of strong consumer economies in emerging countries could help considerably on that score. If something happens to disrupt the process, it doesn't take much imagination to picture a host of troubles: Interest rates most likely jump, the economy slows, and prices of both bonds and stocks get knocked for a loop. Visions of continued rapid global progress abruptly fade.
Such concerns are never to be taken lightly. If the worst fears never become reality, the talk still serves a useful purpose. It helps protect the markets from the dangers of too much optimism.
- BLOOMBERG
