Here's the Truth Behind the Recent Market Rally

NEW YORK (TheStreet) -- Market rallies can cause as much consternation as corrections and pullbacks. Every time there is a significant rally I'm often asked to parse the "truth" behind it to declare exactly what kind of indication it is.

What's really concerning most investors, however, is the level of volatility. It's not been a smooth, upward trajectory. However, the bottom line is that the market -- as measured by the S&P 500 -- currently sits in positive territory for the year and has gained over 18% in the past 12 months. Hardly a poor return.

The truth behind this and any market rally (or correction, pullback, what have you) is you cannot study it in isolation. There will always be some kind of push and pull between market bulls and bears and investors will often react by vacillating between momentum and defensive stocks.

Since the bottom of the market crash in March 2009, U.S. equities have gained some 180% and that, unlike recent blips tied to one company's positive earnings (thank you Citigroup (C)), one economic indicator (the pickup in retail sales last month) or ongoing geopolitical issues (Russia, China) can be tied to real, fundamental factors.

The overall rise of the market has occurred as a result of five critical components:

  • First, the world didn't come to an end as many feared and investors realized that the selloff was greatly exaggerated and created tremendous buying opportunities.
  • Second, as a result of heavy handed intrusion by the Federal Reserve and other Central Banks, supply of money (in the form of QE 1, 2, 3 and Operation Twist) helped drive asset prices higher.
  • Third, the sharp decline in interest rates (orchestrated by central banks) made hard assets and access to capital relatively cheap.
  • Fourth, as a results of items 2 and 3, the global economy started rebounding and eventually got its feet under its ground -- growing at a mild pace, but critically without inflationary pressures to derail the impact of the growth.
  • Fifth, corporate earnings (aggregate earnings of the companies within the S&P 500) soared from just over $16 per share in the first quarter of 2009 to $28.24 in the fourth quarter of 2013 - exceeding their previous peak of $24.06 set in Q2 '07.

It's important to understand this because it shows that markets didn't just rise as a result of artificial manipulation or gimmickry as some would have you believe. Even more importantly, while QE is coming to an end, the other factors that helped drive the market higher are still in place.

That said, no one could argue that U.S. stocks are extremely cheap or represent the extreme values they offered in 2009. However, given that central banks, including our Federal Reserve, have pledged to keep interest rates low for quite some time, that the global economy continues to gain strength and that corporate earnings are expected to continue to rise, we suspect stock prices will also rise. Even in periods when they don't, we remind investors that dividends have historically accounted for just under half of the total return of the market as a whole.

So, the truth behind this rally is that many like it will come -- and more importantly, go.

Expect market volatility to remain at the forefront. Additionally, a short-term correction, perhaps as steep as 10%, should be expected as a normal course of market action.

However, over the longer term, we believe conditions for further gains are present, and that high-quality dividend paying stocks are a great foundation of a growth oriented portfolio. Short-term rallies and corrections will soon be forgotten: It will all come down to continued economic growth and rising corporate earnings in a low-inflation environment that, so far, looks promising.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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