Will this rally continue? Yes and here's why...
The enviroment remains postive for US financial markets. The economy is slowing enough to reduce inflationary pressures, but not nearly enough to affect earnings. And earnings growth continues to surprise on the upside. In fact, operating earnings for the S&P 500 should rise by 16% in the year to Q3, according to Thomson Finanical. This would represent the 13th consecutive quarter of double-digit growth and there has only been one other period since 1950 that matches this record (92Q4 to 95Q4). Quite astounding...
In fact, many question how can earnings growth continue to escalate at this pace? The obvious answer is stronger productivity growth. This has also been aided by the fact that corporate executives have been buying shares in their respectuve companies. Further, it is also widely believed that the Fed will look at cutting interest rates in the first half of next year to enhance economic growth . These factors bode well for our economy; however, there are a number of risks to this hypotesis of growth that I outline below-
Risk 1: Geopolitical problems in the Middle East trigger a super-spike in oil prices sending a deflationary shock throughout the global economy. But with oil under $60 per barrel, we appear to be in good shape (in the near term, at least).
Risk 2: Housing downturn turns out to be much more severe than previously anticiapted. A very high number of mortgage defaults could really put a serious strain on our financial sector. This could be problematic, but with interest halted at this point I don't see this being a problem in the near term as ARMs (adjustable rate mortgaes) have stopped escalating with a slowing of the Fed.
Risk 3: Inflation proves to be higher than expected and much tougher to combat thus forcing the Fed to re-consider any rate-cutting initiatives.
Risk 4: Foreign investment flees the country and the US Dollar takes a hit as a result.
The likely hood of any of these risks actually materializing remain tame at this point but it is still worth noting in the event we want to be certain that we are not caught off guard.
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