2006 takes a soft bounce

Economy lifted by rising profits

December 26, 2006|By Tom Petruno | Tom Petruno,Los Angeles Times

Oil didn't get to $100 a barrel, General Motors Corp. didn't file for bankruptcy protection and 9,000 hedge funds couldn't do enough dumb things to bring down the financial system.

Oh, and there was no bird-flu pandemic, no devastating Atlantic hurricane, and no Federal Reserve interest-rate jump in the second half of the year.

The list of this year's financial market highlights is dominated by what didn't happen.

The non-occurrences helped give Wall Street the confidence it needed to power ahead in 2006.

There was plenty of good news to go along with the absence of bad news: The global economy continued to expand; corporate earnings continued to grow; and long-term interest rates fell in much of the developed world in the second half.

Here, in no particular order, are some of the market memories we take away from 2006:

Failure was not (much of) an option.

GM stock began the year at $19 a share, near its lowest level since 1982, as many on Wall Street figured the ailing automaker was bound for bankruptcy court. But GM is still afloat. And guess which stock in the Dow Jones industrial average has posted the biggest percentage gain in 2006?

Although the Fed, the European Central Bank and the Bank of Japan were tightening credit in unison in the first half - a good recipe for market trouble - financial accidents just didn't happen the way some pessimists dreamed.

Default rates on corporate junk bonds worldwide remain near all-time lows. The mushrooming derivative securities market (futures, options, interest-rate swaps and the like) again didn't live up to the "weapons of mass financial destruction" moniker detractors have given it. And there were few notable casualties among hedge funds, whose go-anywhere investment approach is an invitation to mischief.

To be sure, the housing market has stumbled, as evidenced by rising mortgage defaults. But the rest of the U.S. (and global) economy has shown enough strength that most individual, corporate and government borrowers are making good on their obligations, which in turn has kept financial markets in clover.

Risk, which used to be a four-letter word, has become just a quaint concept.

One natural result of the lack of financial hiccups is that many investors have become more emboldened.

The problem is that, as prices have been bid up, the potential returns in some stock and bond markets seem unlikely to compensate for the risk.

But that's what investors were told a year ago about junk bonds. Those who listened forfeited a near-10 percent return on the average junk-bond fund this year.

Russia's stock market surged 686 percent from 2001 through 2005 - and another 66 percent this year.

The more investors win, the less cautious they become.

But there's also an air of desperation in the hunt for decent returns: The relatively low level of interest rates worldwide means that playing it safe nets you little - 4.5 percent a year in interest on a 10-year Treasury note.

That may only feel like a fair return when every other investment is deep in the red.

What's bad for hard assets is good for stocks and bonds. Some investors had little use for stocks or bonds in the first half of this decade, when their home was the best investment going.

For many hedge funds and other big-money players, commodities were the hot tickets from 2000 to 2005, as their prices began to rocket, fueled in large part by China's boom.

But everyone now knows that the sky really wasn't the limit for home prices. And ditto, it seems, for prices of many commodities.

Crude oil futures peaked at a close of over $77 a barrel in July, and now are at about $63. That is just about where they began the year. Copper, at about $2.90 a pound, has pulled back from nearly $4 a pound in May.

Some commodities still are riding high. But it can't be a coincidence that as some of the air has come out of the tangible-asset bubble, stocks and bonds are having a much better time.

In central bankers we trust. The U.S. stock market wouldn't be so gleeful if it didn't believe that the Fed has achieved its stated goal: a "soft landing" for the economy, meaning a slowdown that will ultimately rein in inflation, without recession.

The Fed keeps warning that it may not be done raising interest rates. Wall Street hears what it wants to hear, which is, "We're having a soft landing; long live the Fed!" Stocks are up, bond yields are down.

European markets also have shown enormous faith in their central bank this year. The European Central Bank has continued to tighten credit even as the Fed has gone on hold since June. But a Bloomberg index of 500 European blue-chip stocks is near a six-year high, nonetheless.

The Fed and the ECB have made money more expensive, but not all that expensive. And there's still plenty of it sloshing around worldwide.

The old analogy is that central banks take away the punch bowl just as the party is getting good. Markets seem certain that the bowl is staying - and that it's half full rather than half empty.

Tom Petruno writes for the Los Angeles Times.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.