Stocks in the Black on Gusher of Cash

By E.S. BROWNING With a 34% rebound in three months, the Dow Jones Industrial Average has pushed into positive territory for 2009, and one of the main reasons is disarmingly simple: Financial markets once again are awash in government cash. The Dow rose 28.34 points to 8799.26 on Friday, as money managers continued shifting funds into stocks. Still, the Dow remains down 38% from its 2007 record of 14164.53, and it had seemed to plateau in recent weeks on worries about the strength of the global recovery. Is the economy on the mend? But governments around the world are pumping money into the economy at a frenetic pace. Because businesses can't put trillions of new dollars to work in such a short time, the money is finding its way into financial markets. Some investors have begun speaking of a "bailout bubble" being created in certain markets, and about a "melt-up" in demand fueled by the growing supply of money. "All that money that was printed had to go somewhere," says Joachim Fels, co-head of global economics at Morgan Stanley. "It has been pushing up commodity prices and stock prices, starting in emerging markets and then pushing over into developed markets." The U.S. government alone has allocated $11.4 trillion to direct and indirect stimulus in the past two years, of which about $2.4 trillion has been spent, according to an estimate by Daniel Clifton, head of policy research at New York's Strategas Research Partners. Most of the money has been pushed out in the past year. The money is gushing from direct grants, central-bank lending, tax breaks, guarantees and other items. China has announced plans for $600 billion in direct stimulus spending; Russia, $290 billion; Britain, $147 billion; and Japan, $155 billion, according to Strategas. Those countries and others are spending trillions more indirectly. "It is quite easily the biggest combined fiscal stimulus the world has ever seen in modern times," says Jim O'Neill, chief economist at Goldman Sachs. "That liquidity will impact anything that is sensitive to it, ranging from short-term fixed-income securities through stock prices through property prices and into people's personal wealth." Some of the market gains, of course, reflect a bet by investors that the worst of the global recession is over, and that investments tied to global growth will be big beneficiaries. The heavy influx of money into the financial system has fueled those bets. If the recession proves more lasting than the optimists believe, liquidity alone may not be enough to keep financial markets rising. American consumers, whose outlays account for more than two-thirds of U.S. economic output, have only begun to rein in spending and reduce debt, a process many economists expect to continue for years. The growing liquidity also is creating serious policy challenges. Senior economists, including Federal Reserve Chairman Ben Bernanke in congressional testimony on June 3, have begun warning that the government can't keep piling up debt at current rates without creating severe financial problems. In coming years, officials will need to raise taxes, cut spending, or both to mop up the ocean of liquidity they have created. That process could weigh on growth and stifle the market boom. Meanwhile, yields of government bonds are rising in anticipation of heavy federal borrowing, and higher yields also hamper growth. On Friday, the yield on 10-year Treasury notes eased a bit to 3.783%, still well up from 2.203% in mid-January. If the government fails to mop up the money, the consequence could be even worse: inflation and a collapsing dollar. Past liquidity-driven booms haven't ended well. In 1998, the Federal Reserve injected cash into the economy to rescue teetering bond markets. The unintended outcome: Technology stocks soared and then cratered. After the government turned on the spigot in 2001 to stave off deflation, residential real estate surged and then collapsed. Now, although almost all markets still are far from past highs, bubbles may be starting to inflate again in speculative foreign markets and other investments linked to global economic growth. For the seventh time this month, the Dow traded above its closing level from last year and finally closed in a new high for 2009. Not all news was good, however, with commodities closing lower. Dave Kansas reports after the bell. Silver is up 59% from December lows on futures markets; copper is up 90%; corn, 45%; and crude oil, 113%. Ukraine's stock market is up 125%, Vietnam's 116%, Indonesia's 76% and India's 87% from winter lows. In Shanghai, crowds are back on weekends on Guangdong Road, where locals gather to chat stocks. Tan Viet Securities Co. in Hanoi says it is opening or reactivating 50 accounts a day, up from five to seven in March. Optima Securities, a brokerage firm in Indonesia, says the number of new accounts has doubled in the last three months. The oil-price rebound is boosting costly projects such as western Canada's oil-sands fields. Imperial Oil Ltd., majority-owned by Exxon Mobil Corp., said May 25 that it is moving ahead with a delayed $8 billion project near Kearl Lake. Canada's stock index is up 41% since March 9. U.S. markets have been among the tamer ones, although some stocks demolished in the downturn have surged, such as banks and home builders. So have companies linked to foreign growth, including Freeport-McMoRan Copper & Gold Inc. and Caterpillar Inc. U.S. companies have reacted to the easier money by issuing new stocks and bonds. In May, Dealogic reported, more new stock was issued by existing companies in U.S. markets than at any time since 1995, when it began keeping records. May issuance of new dollar-denominated junk bonds was the heaviest since June 2007, and the fifth-highest monthly level on record. Worries are spreading that, like previous liquidity-driven market surges, this one could end badly, though many investors believe that won't happen soon. Money supply in major countries, as measured by cash and checking accounts, has been rising sharply relative to gross domestic product, or total value of goods and services, Morgan Stanley reports. Money supply relative to GDP is at the highest level of any period covered by Morgan Stanley's data, which go back to the 1970s. That measure of money supply has tended to move in line with bull and bear markets. It was declining in the late 1980s, ahead of the 1987 crash and the 1990 bear market. It started expanding in 1995, as a major bull market began. It started pulling back in March 2000, as the stock market fell. It then began expanding at the start of 2001, ahead of the next bull, only to top out again at the end of 2006, ahead of the next bear. Now it is surging again. A growing number of money managers are jumping back into stocks, some fearing they will fall behind the surging indexes or believing the world economy finally is poised to recover, led by developing countries. "We're past the crisis," says Jeff Schappe, chief investment officer at BB&T Asset Management in Raleigh, N.C. "The most attractive opportunities are probably going to be in emerging markets and commodities over time." Brett Gallagher, deputy chief investment officer at Artio Global Investors, a money-management arm of Zurich financial group Julius Baer Holdings, says that at some point, the stock market "probably has to correct. But right now, a lot of it is a reflection of the policies that global central banks and politicians have pursued, which are: Reflate at any cost. My guess is that it probably will run longer than fundamentals will dictate it should," just as the tech-stock and the real-estate bubbles did before they finally popped. —Mark Gongloff and James T. Areddy contributed to this article. Write to E.S. Browning at jim.browning@wsj.com