Stock Market Forecast for 2013

As the S&P 500 Index hits a five year high, many observers suspect that the long awaited rotation from bonds to equities is now underway and likely to propel the market to all time highs. The irony is that most evidence to support the bullish view is the direct result of an unprecedented Federal Reserve policy designed to prevent a stock market collapse and a deep and protracted global economic depression. The fact is that equities have never been so cheap compared to bonds and the housing and financial sectors of the economy seem to be recovering nicely in recent months. Bears know that the Fed’s commitment to keep interest rates near zero indefinitely has been a key factor in fueling the stock market rally and spurring the recovery in housing and bank asset prices.

Regardless of mindset, both bulls and bears know that a market attaining its current lofty level is ripe for a meaningful market correction and sooner rather than later. Additionally, bears know that most if not all of the many serious domestic and global challenges that caused the 2008 financial crisis still hang over us, even if the talking heads appear oblivious to them recently. Bears are skeptical and believe that the economic recovery might be illusory, especially considering that all major global economies—US, Euro Zone, China, and Japan—continue to face significant political, economic and financial headwinds. Consequently, it should be apparent to even the most optimistic observers that there is now far more downside risk than upside potential in the stock market, at least until there is some convincing evidence that the “powers that be” understand that measures to postpone dire circumstances may work in the short term but do not provide a permanent fix to the long term challenges we face.

Furthermore, bulls know that a recovering economy will prompt the Fed to take away the monetary punch bowl and let interest rates rise in an attempt to avoid overheating the economy and precipitating runaway inflation. History shows that the Fed does not often respond appropriately and in a timely manner and uncertainty about future Fed policy, in addition to the effectiveness of the policy itself, could easily cause a major stock market correction. Rising interest rates will surely weigh heavily on the stock market too as they reduce corporate earnings, exacerbate our national debt and deficit and hinder the finances of already struggling municipal and state governments.

The stock market rally may be a sign of irrational exuberance.