Not even a default by a rich European nation could knock stock markets off track for long.
A day after Greece missed a critical debt payment to the International Monetary Fund, markets were back in the green, gaining back significant ground after the selloff earlier this week. European markets were broadly up 2 percent, while Asian markets surged with the exception of China. At home, the Dow Jones industrial average climbed 138 points to end up 0.8 percent at 17,758.
The response was the latest example of the resiliency of stock markets ever since they bottomed out in 2009 as banks collapsed, profits dried up and corporations slashed costs. Households watched their 401k balances shrivel, and forecasters feared an entire generation of wealth would be lost.
Instead, stock markets have been on a seemingly unstoppable rally. Key indexes have doubled in value or more, even as the world economy logs disappointing growth year after year.
The question, however, is whether financial markets are out of sync with economic fundamentals and fail to reflect vulnerabilities, like the risk of Greece's default sparking a panic. If so, some investors worry that heralds a potentially painful adjustment down the road.
“Stocks are richly valued relative to history,” said Matthew Coffina, editor and portfolio Manager of Morningstar StockInvestor. ”I wouldn’t say that the market is guaranteed or destined to crash right now, but I would say the history is not encouraging.”
The global economy grew by a middling 2.6 percent in last year, according to the International Monetary Fund, about the same rate of expansion as the previous two years. This year, growth is expected to clock in at a modestly higher 2.8 percent. But the 3 to 4 percent growth enjoyed before the global recession remains elusive.
The reasons behind such lackluster growth are many and varied. Many European countries enacted severe government spending cuts to control ballooning debt. Japan is battling a deflationary cycle that has lasted 20 years. In the United States, economists have pointed to a shrinking labor force and an overhang of household debt.
Yet all of these economies have relied on one main tool to boost growth: easy money.
The central banks in the United States, England, Europe and Japan, along with those in several smaller countries, have slashed their benchmark interest rates to zero and pumped money into their economies. Their ultimate goal has been to boost growth by making borrowing extremely cheap, which in turn prompts consumers to spend and businesses to invest.
But ultralow interest rates more directly impact financial markets. Easy money encourages investors to take bigger risks, driving a runup in equities.
Since the U.S. Federal Reserve announced an open-ended stimulus plan in late 2012, the blue-chip Dow Jones Industrial Average has hit a new high nearly 100 times. It averaged a new record once a week during 2013. The European Central Bank unveiled a similar program early this year, sending markets there up by double digits. The Nikkei index has doubled in value in recent years amid aggressive stimulus from the Bank of Japan, yet the country suffered a recession in 2014.
“I don’t think we’re in bubble territory or anything like that, but I think that monetary policy is doing its work,” said Paul Sheard, chief global economist at Standard & Poor’s.
The one exception, analysts agree, could certainly be China. The Shanghai Composite Index is one of the best-performing in the world, doubling in value over the past year. Chinese officials have targeted an annual economic growth rate of 7 percent, but the country's breakneck expansion has slowed considerably and expected to come in just shy of that goal this year. The People's Bank of China has slashed its benchmark rate to a record low over the weekend as markets swung wildly over the past few days. The Shanghai Composite plummeted five percent at the end of Wednesday's trading session after gaining a similar amount the day before
Some analysts worried the turmoil in Greece could be the catalyst for a correction not only in Europe but around the world. The breakdown in negotiations over a bailout plan could wind up forcing Greece to drop the currency it shares with 18 other European countries and destabilize the entire region.
When Athens defaulted on its debt in 2012, the Euro Stoxx 50 index, which tracks companies within the so-called Euro zone, plunged more than 20 percent in less than three months. But the country averted crisis with a bailout package that restructured its debt. The Euro Stoxx regained all of its ground -- and then some -- by the end of the year.
It is unclear how the drama in Greece will end this time. Prime Minister Alexis Tsipras softened his stance toward creditors' terms of a bailout on Wednesday morning. He has called a referendum for Sunday that puts the future of any deal in voters' hands. But with Greece’s neighbors in a stronger economic position and a promise from the region’s central bank to do “whatever it takes” to support the single currency, the response from investors has been far less dramatic than it was in 2012.
“Sure this is going to have long-run implications, but the near-term the reaction in the Spanish or Portugese or Italian markets has been relatively muted,” said Desmond Lachman, resident fellow at the American Enterprise Institute. “It’s right for markets not to be panicking.”
Still, all but the most bearish investors stop short of declaring that markets are in a bubble. Global growth may still be weak, but it has picked up in recent years. And a strong stock market can feed back into the economy through increased investor wealth and spending.
Perhaps the biggest test of the rally’s strength could come later this year. The Fed expects it will raise its benchmark interest rate for the first time in nearly a decade, which would make it the first major central bank to begin backing off its easy money stance. Investors are nervous that an increase in rates could shift the dynamic of the markets.
Fed officials have cast the withdrawal of central bank support as a sign of the strength of the U.S. economy. The irony is that a vote of confidence in the recovery could be just the thing that ends the global bull market.
“Stock prices don’t always follow economic fundamentals,” Coffina said. “It works in both directions.”