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Has the bull market in stocks become 'too big to fail'?

The Federal Reserve's efforts to keep the U.S. economy growing may not work unless the stock market keeps moving higher.

March 03, 2013|By Tom Petruno
  (Chris Whetzel, For The Times )

Officially, the Federal Reserve isn't supposed to worry about keeping stock prices flying high.

But when Fed Chairman Ben S. Bernanke was asked about the market's outlook last week on Capitol Hill, he sounded like a lot of bullish Wall Street investment strategists.

"I don't see much evidence of an equity bubble," he told the Senate Banking Committee in his semiannual testimony on Fed policy. Stocks "don't appear overvalued given earnings and interest rates."

More important for the markets, Bernanke pledged to continue the Fed's policy of pumping colossal sums into the financial system to support the economic recovery.

As stocks flirt with the record highs reached just before the global financial crash of 2008, memories of that catastrophe loom large. Many Americans have abandoned equities since the crash, terrified of living through another one.

Yet the Fed's efforts to keep the economy growing may not work unless the stock market keeps moving in one direction from here: higher.

"Too big to fail," the label derisively given to the nation's biggest banks, now could also be applied to stocks' 4-year-old bull market.

"The Fed and the other central banks cannot afford to see a massive decline in equity prices," said Mohamed El-Erian, who oversees $2 trillion as chief executive of money manager Pimco in Newport Beach.

Steven Ricchiuto, chief economist at Mizuho Securities USA in New York, puts it another way: If the stock market were to fall drastically, "You would have every economist screaming 'Depression!'"

That might not be what would actually unfold, Ricchiuto said. But the effects on the fragile global economy would be painful nonetheless, he said.

Corporate executives, fearing that a sustained market slide was signaling a new economic slump, could quickly react to tumbling stocks by launching a round of severe job cuts to protect their rich profit margins, as they did in late 2008 and early 2009. That could torpedo the fledgling jobs recovery and make an economic downturn self-fulfilling.

What's more, a market plunge could trigger spending cuts by well-off consumers who control most of the nation's wealth, and who have therefore benefited the most from stocks' rebound since 2008. The top 20% of U.S. households by income account for 38% of consumer spending.

A strong footing

For now, the bull market still appears on strong footing: The Dow Jones industrial average ended Friday at 14,089.66, up 115% from the crash low reached on March 9, 2009 and just 0.5% below its all-time high set in October 2007.

Shares also have rallied sharply in Europe and Japan in recent months, and policymakers in those economies are eager to see the markets build on those gains as a sign of confidence.

European Central Bank Chief Mario Draghi is credited with sparking the turnaround in stocks in Europe and the U.S. last summer after he vowed to do "whatever it takes" to ensure that the continent's debt struggles wouldn't break up the Eurozone. An index of 600 blue-chip European stocks has jumped 23% since June.

Draghi's resolve is being tested again after Italy's recent election, as voters rejected the government spending cuts that were aimed at calming fears about the country's debt load. But like Bernanke, Draghi last week offered comforting words, saying the ECB was far from ending its program of providing money to the financial system at near-zero interest rates.

In Japan, the Nikkei-225 share index has rocketed 34% since mid-November to 11,606, the highest level since 2008, as the new government led by Prime Minister Shinzo Abe has pledged fresh efforts to stoke the flagging economy. That also has driven down the value of the yen, a boost for Japan's all-important export giants.

Japan's economics minister, Akira Amari, last month went so far as to set a target of 13,000 for the Nikkei by April 1. The new government wants to take more steps "to help stock prices rise," he said.

Neither U.S. nor European policymakers would be bold enough to try talking up the market that explicitly. But they all have the same goal in trying to armor-plate this bull market: revive the so-called virtuous circle, wherein higher stock prices feed economic confidence, which in turn feeds more market optimism and encourages companies and investors to take more risk. That, in theory at least, should boost economic growth.

'Lost decade'

With major U.S. stock indexes at or near all-time highs, market bulls face the challenge of persuading sidelined investors that it's not too late to get in. A central tenet of the bulls is that stocks have ended the painful "lost decade" of the 2000s, when the market made no net progress. The optimistic view is that Wall Street since 2009 has been in a new "secular" bull market, meaning an advance that will be long-lasting, such as the 1990s' rally.

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