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inside the market

The S&P 500 has been hitting a succession of new highs after scaring us with a near-correction just one month ago. The big question now: Why?

It's not as though U.S. valuations have fallen into bargain territory or the global economy has suddenly swerved toward strong growth, free of central bank assistance.

The answer has more to do with the fact that the fears that drove the selloff in September and October simply haven't become anything real.

"It's hard to believe that only a few days ago, investors were scared out of their wits about impending elections, a deteriorating economy in Europe and truly scary news about the Ebola virus," said Eddy Elfenbein on his market blog, Crossing Wall Street. "How times have changed!"

Or at least our focus has changed. The euro zone economy continues to plod along with growth of 0.2 per cent in the third quarter – dismal, but ahead of expectations and a sign that things aren't getting worse.

More to the point, the U.S. economy still looks as though the rest of the world isn't dragging it down. Retail sales are strong, employment is improving and consumer confidence has hit eight-year highs.

"It shouldn't be a surprise that confidence is riding high," said Paul Dales, senior U.S. economist at Capital Economics, in a note.

"After all, employment growth is strong, equity prices are back at record highs, and gasoline prices are plunging. In short, the household sector as a whole is in a better position now than it has been for many years."

Corporate earnings are supporting the optimism. For companies in the S&P 500 that have reported their third-quarter results, earnings have risen more than 10 per cent from last year, which is encouraging.

That supports the view that, while stocks aren't cheap, rising earnings can still drive share prices higher and keep the bull market charging ahead.

Well, that's the hope. The remarkably fast rebound in stocks comes with a downside: If the near 10-per-cent decline last month was supposed to be healthy – washing out our exuberance, forcing us to take a good look at our risk tolerance and reducing stock valuations for better long-term gains ahead – then today's new highs are a cause for concern.

They make stocks appear invulnerable to prolonged setbacks, which is a dangerous outlook to have because stocks never are.

Michael Hartnett, chief investment strategist at Bank of America, recently warned of hubris among investors. And Ed Yardeni of Yardeni Research has expressed some worries about a "melt-up" in stocks, defined by short-term gains that are divorced from fundamentals.

Other observers, though, are convinced that such worries are typical of any bull market, and that investors should be positioned for a considerably longer run of strong returns.

"Both investors and corporations continue to act conservatively because of the uncertainty caused by a litany of issues," said Richard Bernstein of Bernstein Advisors, in a note, identifying everything from worries about falling profit margins to fears that the economy can't survive without bond-buying stimulus from the U.S. Federal Reserve.

"Uncertainty is typically the engine of bull markets," he said.

Adam Parker, chief U.S. equity strategist at Morgan Stanley, couldn't agree more. He argues that the current U.S. economic expansion could be a record-breaker in terms of its longevity, given that a number of broad economic indicators have only just reached normal levels for an expansion.

An ongoing expansion should boost stocks for at least another five years, he believes, pointing out that an average of 6-per-cent growth in earnings a year could lift the S&P 500 to a potential peak of 3,000 by 2020 – or nearly 50 per cent higher than Friday's close.

No wonder investors have been pouncing on every dip as a buying opportunity.


If Morgan Stanley's Mr. Parker is right and the bull market continues for at least another five years, there are 45 stocks he thinks will do particularly well. See the full list online here.