You can also see it in the options market, where bets that stocks will rise now far outpace bets that stocks will fall. Options traders are also betting that stocks simmer down and stop making big swings day after day.
And you can also see this in the credit market. High-yield "junk bonds" remain well off their lows of early August. And in the credit-derivatives market, where people bet on where interest rates are going, sentiment is shifting. Société Générale's Fidelio Tata notes that institutional clients are showing increased interest in "payer swaptions" -- a swap option that pays out in a big way when interest rates rise through inflation, economic growth or both. That is, in effect, a bet on economic improvement and a rising stock market.
This isn't the end of the world
But how can an optimistic outlook possibly be justified when bad news is all around?
Yes, I know the economy stinks. No jobs were created in August. Factory output slowed. Consumer and business confidence is in the tank. The eurozone is struggling amid German demands that Greece and others balance their budgets in the midst of economic decline (sound familiar?) and political recalcitrance from the likes of Finland and Slovakia over bailout funding. Banks are under pressure for European exposure, stiff new regulatory burdens and a massive new lawsuit from the government.
Yet the fear goes beyond economics. There is a feeling out there that the social fabric is beginning to fray, that maybe -- just maybe -- the risk of a dystopian, "Mad Max" nightmare is beginning to rise. How else can you explain the feverish obsession with holding physical gold bars and coins?
We've had the "Arab Spring" uprisings in Tunisia, Egypt and Libya, with Syria up next. Violent protests have been seen all across Europe -- sit-ins in Madrid, clashes in Athens, looting and arson in London. India has been rocked by anti-corruption hunger strikes. Even tightly controlled China is facing outrage in the wake of a tragic high-speed train crash. Chileans are demanding higher social spending. And in Israel, nearly 500,000 people have taken to the streets over the rising cost of living.
The United States isn't immune. Remember the battle over union rights in Wisconsin that turned the state capital into a mob scene?
Yet in the face of all this, I remain hopeful. And based on the evidence above, the smart money is thinking the same way.
Reasons to expect a turn
The fact is, this isn't 2008. The preconditions for a new recession aren't in place. And that means that stocks, relative to overpriced bonds, are a bargain -- just as they were this time last year, ahead of an epic 32% rally that ran into May.
For one, far fewer companies are at risk of bankruptcy now than three years ago. Corporate profitability has been pretty much the only segment of the economy to fully recover from the 2007 recession and is pushing to record highs. The surge of cash has strengthened balance sheets: Back in 2008, nearly 25% of the top 1,500 nonbank companies had more short-term debt and other obligations than cash, compared with just 14% now.
There's more. Inventories are light. Businesses are underinvesting. Credit markets are functioning normally, with business having no problem raising cash for today's operations or future needs. And housing activity, the big drag in the last recession, has stabilized near its lows and is unlikely to cause problems on the same scale. Construction activity is already so low that I don't see if falling much further.
As for the job situation, productivity is falling while unit labor costs are rising. Both are historical precursors to a pickup in hiring. Provided we can keep the economy out of the ditch, job gains should reaccelerate.
Plus, global growth remains respectable. The emerging-market countries now account for nearly half of the global economy. Thanks to balance-sheet strength and rising incomes in these countries, Credit Suisse strategist Andrew Garthwaite is looking for global gross-domestic-product growth of 3%. That's not great -- down from the 4.7% growth the International Monetary Fund thinks the world is capable of and the 3.5% growth averaged over the past 20 years -- but it's enough, especially with inflationary pressures beginning to cool (the main concern facing China, India, and Brazil).
Stimulus is on the way
And finally, I stand by my prediction that additional monetary and fiscal stimulus is on the way.
President Barack Obama, worried about falling poll numbers and the 2012 election, is set to propose $300 billion package of tax cuts, infrastructure spending and aid to local and state governments. According to reports, he will also offer a $50 billion public works and schools construction package and a $30 billion tax credit for businesses that hire unemployed workers. The package is to be combined with medium-term deficit reduction measures.
He will challenge the Republicans -- the party of tax cuts -- to vote against his plan. While they will likely fight parts of it, I don't think they'll torpedo the majority of the plan. And that should lessen the impact of planned budget austerity that I worried about in last week's column, "Why Obama needs to spend more."
Additional action from the Federal Reserve is now all but certain, according to Société Générale senior U.S. economist Aneta Markowska. I don't think another round of money printing -- called "quantitative easing" or "QE3" -- is likely just yet. I'm looking for the Fed to reinvest its assets into long-term Treasury bonds or mortgage securities, as discussed in "Can the Fed chief calm our fears?" This is known as "duration extension" and was dubbed "Operation Twist" when it was tried in the 1960s. Markowska notes that the question isn't whether it's going to happen, only whether it's going to happen at the September or October policy meetings.
