So, some people are a little confused by this week’s huge rally in the stock markets. After all, Europe’s debt crisis isn’t over and the U.S. economy has its share of problems.This week’s activity was all about Wednesday’s EU leaders’ summit. Ultimately, the markets were pleased. The Dow Jones Industrial Average jumped 339 points in its first trading session after the summit.
However, analysts’ takes on the EU leaders’ proposals were mixed. And most warn there are major issues regarding the implementation of any of the agreed upon proposals. Bottom line: Europe is far from being fixed.
So, why did the stocks markets close 4% higher for the week? Here’s what Michael Santoli says In the new issue of Barron’s:
Sometimes, when enough folks are positioned for the world to end rapidly, the mere suggestion that it might occur gradually is enough to energize the bidders.
In other words, bad news can be good news if you are expecting worse. And stock markets are priced based on expectations of the future.
And expectations were extremely low going into Wednesday’s EU leaders summit. On Tuesday, the UK had confirmed that Ecofin, or Europe’s financial ministers, would not be meeting ahead of the summit. This suggested to everyone that next to nothing would be accomplished by EU leaders on Wednesday. The Dow dived 207 points on the news.
So, when the EU leaders emerged from the summit with the semblance of an actual plan to fix the eurozone debt crisis, markets were pleasantly surprised and so they rallied.
But make no mistake. Markets are far from displaying exhuberance that could be considered irrational. They still seem to have reservations about the future. The S&P 500 is up a mere 2% since the beginning of the year. And at 1,285, the S&P 500 is trading at just under 13 times this year’s earnings. This is a discount to the long-run average of around 14 or 15 times earnings.