â¿¿ OPTIMISTIC INVESTORS:
A new love of stocks could prove a powerful force pushing prices up. In fact, it can push them up even if earnings don't increase.
That's what happened in the five years through 1986. Earnings fell 2 percent, but the S&P 500 almost doubled as small investors who had soured on stocks throughout the 1970s returned to the market. The multiple â¿¿ shorthand for the price-earnings ratio â¿¿ rose from eight to nearly 17.
Market watchers refer to this as "multiple expansion." Will it happen again?As stocks have surged over the past four years, individual investors have been selling, which is nearly unprecedented in a bull market. But they may be having second thoughts. In January, they put nearly $20 billion more into U.S. stock mutual funds than they took out, according to the Investment Company Institute, a trade group for funds. Some financial analysts say we are at the start of a "Great Rotation." That would mean investors shifting money into stocks from bonds. If that happens, stocks could soar. It's too soon to say if the buying will continue. Howard Silverblatt, senior index analyst at S&P Dow Jones, thinks investors are too worried about the future of the euro and government spending cuts to dive into stocks like they did in the 1990s. "We don't have a lot of confidence going forward so people are limiting what they're willing to wager," he says. â¿¿ LOW INTEREST RATES: Interest rates are near record lows. That's good for stocks because it lowers borrowing costs for companies and makes bonds, which compete with stocks for investor money, less appealing. If you want to kill a stock rally, then hike interest rates. That's what happened in the run-up to Black Monday, Oct. 19, 1987. In August that year, the yield on the 30-year Treasury bond rose above 10 percent. Investors thought, "If I could make 10 percent each year for 30 years in bonds, why keep my money in stocks?" So they sold and stocks drifted lower. Then Black Monday struck. The Dow plunged 508 points, or nearly 23 percent â¿¿ its largest fall in a single day.