Stock market faces its next challenge: Good news

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Good news is breaking out just about everywhere you look these days – and the best part is that the stock market isn't taking much notice yet.

Sure, the S&P 500 touched a record high earlier this month and is up more than 19 per cent this year, implying that the mood is at least somewhat upbeat.

But you don't get the sense that euphoria has broken out. Consider that over the past four months, the benchmark index has gained less than 2 per cent, reflecting some caution on the part of investors.

And from the index's pre-financial crisis peak, in 2007, the S&P 500 is up just 8.2 per cent, which works out as a lacklustre gain of just 1.3 per cent a year.

Now assemble a list of the most newsworthy trends in recent weeks and you might be startled by what looks like a wonderfully bullish backdrop for equities.

Ed Yardeni, head of Yardeni Research, assembled such a list in his latest note to clients, surveying the situation in the Middle East, Europe and North America.

His take? "The odds of bad things happening that could unsettle financial markets over the rest of the year have diminished in recent weeks."

Consider that immediate geopolitical risks have subsided now that Syria has agreed to destroy its arsenal of chemical weapons – heading off potential military strikes, fears of a wider regional conflict and a spike in crude oil prices.

In Iran, the new government under President Hasan Rouhani is attempting to recast itself in a moderate image, even initiating talks to resolve a long-standing conflict over its nuclear program.

The Middle East might not be sprouting flowers yet, but the impact on oil is certainly pleasant: After hitting a two-year high above $110 (U.S.) a barrel and raising concerns about a drag on global economic activity, oil has since backed off by $8, retreating toward a three-month low.

In Europe, once the source of the world's biggest economic concerns, the sovereign-debt crisis has faded and growth – albeit slight – has returned. Most recently, Angela Merkel won an overwhelming victory in German elections, erasing concerns that a shift in government could destabilize the euro zone's recovery.

In the United States, the Federal Reserve has taken a more dovish tone in its monetary policy, backing off from imminent plans to taper its bond-buying stimulus program – even as the economy grows at a respectable 2.5-per-cent pace and the unemployment rate slides toward 7 per cent.

Bond yields, which had been surging since May and threatening to take down consumer spending and the housing market, are now settling down. The yield on the 10-year U.S. Treasury bond hit a two-year high of 3 per cent earlier this month, but has since fallen to about 2.64 per cent.

Add it up and you might feel a bullish twinge. Yet the market is focused on the downside risks, mostly associated with another political showdown in Washington over the U.S. budget and debt ceiling.

Is this really a big concern for investors? The U.S. Treasury has warned that the country will run out of cash by Oct. 17, soon after the start of the new fiscal year, if no agreement is reached.

But investors have seen this sort of drama before, without witnessing any long-lasting impact on the stock market. Even credit rating agency Moody's Investors Service doesn't sound too worried about the outcome, saying that a failure to reach an agreement is a "short-term event" that likely won't affect the U.S. credit rating.

And if Washington does manage to cobble together a fiscal agreement over the next couple of weeks, one more source of stress on the equity market will be gone – easily paving the way toward a year-end rally.

The stock market has done just fine over past four years, often when the news has been grim. Let's see how it does when the news is overwhelmingly good.