Stock market may seem out of touch, but its rally is built on solid ground

Yes, Wall Street is out of touch with the real world.

That was the reaction of most Americans as the stock market zoomed from one record high to another last week. But it’s also the normal state of affairs, and there’s nothing sinister about it.

Those of us who live in the real world find our lives shaped by the past and present. Jobs are hard to find, household budgets are tight and homes don’t sell for what they used to.

The stock market — or, really, the millions of people making independent investment decisions — knows all that, but its job is to predict the future.

The market cares less about the absolute level of economic activity than about the direction and rate of change. That’s why stocks can surge even as unemployment remains high, as long as it’s expected to keep falling.

Isn’t Europe in recession, and aren’t politicians in Washington deadlocked over the budget? Sure, but that’s old news, already reflected in stock prices. What matters is that investors think those problems will get better, or at least can’t get much worse.

“The equity market trades on improvements in trend,” says Jim Russell, senior equity strategist with U.S. Bank Wealth Management in Cincinnati. “No, we’re not at fast growth rates or full employment, but it’s a fact that things are improving slowly and are likely to continue to improve.”

Last week, a string of such marginal improvements were enough to propel the Dow Jones to four straight record highs. On Friday, the big news was a better-than-expected U.S. employment report.

“This is the most hated, disbelieved all-time high in the stock market that I can remember,” Russell says. “People don’t feel wonderful about it.”

Even so, he thinks the rally has been built on solid ground. The Federal Reserve shows no signs of reversing its easy monetary policy, corporate profits are expected to grow about 8 percent this year and price-earnings ratios are reasonable.

Consider Apple. The longtime market darling has seen its share price fall 35 percent in the past six months, and it trades for less than 10 times earnings. That’s certainly not a sign of a frothy market.

Figures from the mutual fund industry show that, in the last two months, individual investors have put more money into stocks than they took out. The amounts are relatively small, though, and don’t begin to make up for more than three years of net withdrawals.

“I don’t know what it could do to prices, but it seems like there’s a lot of money that could still flow into stocks,” says Ken Crawford, an analyst at Argent Capital Management in Clayton.

Norman Conley, chief investment officer at JAG Advisors in Ladue, characterizes the recent inflows as “scared money, going into safe-haven, high-dividend stocks.” Again, that hardly sounds like a bubble.

Interestingly, the Dow’s latest record high came almost on the four-year anniversary of its bear market low. The index is up 120 percent since March 9, 2009, when we still didn’t know if the financial crisis was going to end, and when comparisons to the 1930s were on everyone’s mind.

If you take the long view, then, the market and the real world really are in sync. We may think that jobs should be more plentiful, houses more valuable and politicians less contentious, but we have to agree that the world economy is less scary than it was four years ago.