The stock market acts as though it is on the verge of doing the unthinkable.
The broad indexes have rallied for the past three months, raising the specter of a renewed bull market. I call it a specter because hardly anybody has been saying a new upsurge in stocks is what would, or should, happen.
Bears, as is their wont, have been forecasting declines. What passes for the bullish camp has been predicting moderate gains at best. If there is one universally accepted dogma, it is that stocks -- and most other asset classes, for that matter -- are due for low returns as far as the eye can see.
This conclusion was not idly arrived at. All sorts of smart people say a strong advance is somewhere between unlikely and mathematically impossible. Yet here we have the Standard & Poor's 500-stock index up 7.2 percent in the past three months, including dividends, bringing its gain from the bear-market low in October 2002 through the end of July to 62 percent. The small-stock Russell 2000 index has jumped 17.7 percent since the end of April and has now doubled off the low less than three years ago.
Behold a textbook example of a securities market defiantly doing what is least expected of it. If stocks managed to show any strength this year, the gains were supposed to be concentrated in big stocks, which represented a much better value after more than five years of small-stock dominance.
"In June, the small cap stocks busted out all over," writes Jeremy Grantham, chairman of the money manager Grantham, Mayo, Van Otterloo & Co. in a Web site commentary published July 27. "In general they look overpriced and overleveraged. This . . . may be a good, and possibly last, opportunity to reduce" holdings of them, he says.
Stocks aren't the only market behaving contrarily. They are following the recalcitrant example of the bond market, where yields on 10-year and 30-year Treasury bonds remain lower than they were at this time last year, brushing aside a barrage of money-market rate increases by the Federal Reserve.
To see a defiant spirit in markets isn't some anthropomorphic whimsy. Their contrary tendencies are a natural fact, since whatever is expected of them is already reflected in prices at any given time. If something is going to cause prices to change, it must be unexpected in some way.
Thus, if stock prices attract more believers as they keep rising, the prospects of still-further gains would stand to diminish. Fortunately for us bulls, a huge reservoir of skepticism remains.
Much of the smart money is now committed to the pursuit of "absolute return," looking opportunistically for chances to make money on either side of the market, as many hedge funds do. This money cannot easily revert to simple bullishness on stocks without recanting a proud intellectual point of view.
Says mutual fund manager Ron Baron in the latest quarterly report of his Baron Funds, "We believe the strong interest by so many in hedge funds has allowed our mutual funds to purchase interests in attractive growth businesses at valuations lower than they might have been were so many not interested in short-sale strategies (and indexing)."
Baron, while a longtime advocate of smaller to medium-size growth stocks, is no bullish automaton. One of his company's fastest-growing funds, the $1.1 billion Baron Partners Fund, can sell stocks short as well as buy them, though at last report it was heavy on the long side.
The same orneriness that enables the stock market to rise when it isn't supposed to guarantees that whatever it is going to do next defies prediction. So if I assert, as I now do, that stocks are in good position to keep advancing -- well, I am obliged to admit that all forecasts are suspect, including this one.
Still, the possibility of a revived bull market demands attention, if only because it is such an unpopular view. As stock prices rise, doubters can be counted on to assert that the market is only increasing its vulnerability. How can these investors do otherwise, having already painted a picture of most stock prices as unattractive?
Meanwhile, the U.S. economy in general, and corporate profits in particular, persist in looking better than expected. So does the stock market.