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The Path Of Least Resistance Is Up

There is so much skepticism with respect to stocks that most everyone who might be scared out of the market has already exited. Investors fear a credit meltdown in Europe following a Greek default. They also fear a weakening domestic economy. As a result, stock prices are depressed, despite solid earnings growth and a healthy corporate sector. If investor's fears are not fulfilled, stocks should move higher.

Investors have been anticipating a credit market collapse in Europe since March 2010. The risks of a meltdown have not been resolved as yet, despite the ongoing collaborative efforts of Germany and France, so this has become very old news. Investors should be well prepared for anything, except a total credit meltdown. Similarly, domestic growth slowed in response to rising energy costs and higher food prices, which weakened discretionary income, and industrial production declined due to parts shortages as a result of Japan's tsunami. The expansion regained some vigor in the fourth quarter despite these adverse shocks. And with the housing market now beginning to recover, a new impetus for growth will help.

The equity market became considerably cheaper in 2011, as earnings maintained a strong upward trajectory and stock prices failed to follow suit, so stocks became cheaper. Yields on Treasury bonds declined, which tilted the pre-existing balance favoring stocks even more in that direction. Investors are simply not positioned for this mix. Many retail investors have fled stocks for the safety of Treasury bonds, yet interest rates are unsustainably low, so the risk of owning Treasuries is high. Investors did not bargain for losses when they fled into the safe haven of Treasury bond investments.

Monetary policy remains highly supportive on both sides of the Atlantic. The ECB has engaged in quantitative easing, even if it wasn't characterized as such. Domestically, the Fed is also committed to economic recovery and will keep interest rates low until this outcome is assured. Therefore, all the key variables are aligned to promote a rebound in stock prices, barring any adverse shocks. Even then, the economy has demonstrated its resilience. So we remain attracted to the more cyclically sensitive parts of the equity market and we are steering clear of U.S. Treasury bonds.