Watch out for a swing to fear

Global stockmarkets have made "a firm start" to the New Year, says Bill Jamieson in The Scotsman. America's S&P 500 index and Britain's FTSE 100 have respectively reached a 21 and 18-month high as good news "has been rolling out". US consumer confidence "is gaining real momentum", with the University of Michigan's consumer sentiment index registering its biggest monthly jump since 1992, while thanks to a series of strong earnings statements, S&P 500 companies look set to beat Wall Street's 23% year-on-year earnings growth forecast for the fourth quarter of 2003. In Britain, the latest Ernst & Young ITEM Club forecast predicts growth of 3% amid a recovery in exports and business investment, rising incomes and consumer spending growth. Corporate earnings per share, meanwhile, are expected to expand by 16% this year. Throw in the uptick in takeover activity signalled by the JP Morgan/Bank One deal and the "massive amounts" of money being funnelled into equities from bonds and cash, and it seems that for now "there is no stopping" this bull run, says The Business. The indices could gain another 5% before the autumn.

Don't count on it, says Jamieson. A slowdown in the pace of UK public spending in response to the burgeoning budget deficit and a delayed recovery in business investment "could bring disappointment" - it would leave the economy dependent on the overstretched housing market and highly geared consumers. And in America the twin deficits are so huge that Wall Street investors seem like "tap dancers on Vesuvius". Further falls in the dollar will reduce the appeal of US assets and make foreigners increasingly reluctant to buy in, potentially turning the greenback's slide into a rout. Meanwhile, recent news on employment growth has been "troubling", says John Mauldin in Investors Insight. Stephen Roach of Morgan Stanley notes that between August and November it was far below levels typical at this stage of the cycle, despite economic growth of 8%. A recent survey reveals that temporary retail employment actually fell over Christmas and inflation-adjusted earnings declined in December. In short, says Dailyreckoning.com, the recovery is "missing more than a few teeth".

A more immediate worry is the "revival of bubble psychology" on Wall Street, says Alan Abelson in Barron's. Day traders have resurfaced, "the worst stocks are getting the best rides", and short-sellers have become "an endangered species". Note that both the S&P's and the Nasdaq's implied volatility indices - proxies for investors' greed or fear - are in "naked greed territory", says Adam Hamilton on Zealllc.com. This heralds a coming swing of the pendulum back to fear. "And stock prices always follow closely on the heels of popular emotion."

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