Trying to second-guess stocks is harder than ever

EQUITY investors haven&rsquo;t had much time for clich&eacute; this year. Earlier this year, they ignored dire predictions &ndash; coming from anyone with a keyboard or a microphone &ndash; that financial markets might never recover. Instead, they seized upon historically low valuations &ndash; and the trillions spent by governments around the world &ndash; and began the strongest stock price rally in at least two generations.<br /><br />They shrugged-off the &ldquo;sell in May and go away&rdquo; nonsense, rejected the idea of a &ldquo;summer lull&rdquo; and pushed past the market shibboleth that warned of a disastrous September. By the time the supposed worst was over, the FTSE 100 had recorded its best quarter gain in history and a 42 per cent advance since <br />March lows.<br /><br />This past week, however, has been&nbsp; more testing: the FTSE has declined for four straight days; economic data has begun to show signs of a delayed recovery; and investors are finally starting to get unnerved about the fiscal mess that will be left to clean up.<br /><br />The result has been an overriding sense of nervousness in financial markets as heretofore truisms (stock and bond prices generally move in opposite directions; investors shun the currencies of profligate Treasuries) seem no longer valid as bond yields continue to fall (despite record sales from nearly every country in the G20) and traders buy back the dollar (with its record $1.6 trillion deficit).<br /><br />So where next? The final quarter of 2009 will rest on whether the fact that companies have thus far delivered better-than-expected quarterly results largely based on cost-cuts and sackings (with little or no top line revenue growth) continues to override the fact that unemployment is still moving in the wrong direction.<br /><br />On the market side of the ledger, you can&rsquo;t ignore the fact that the relentless fall in bond yields has made M&amp;A financing incredibly attractive. Cash-rich firms are seeking to capitalise on this, which&nbsp; adds a tidy bid premium to the stock market. <br /><br />However, consumer behaviour remains tough to predict, especially in the UK where house prices appear to have stabilised and spending remains resilient, but where &shy;citizens have added &pound;3.3bn to their savings while only trimming personal debt by around 0.6 per cent so far this year. And this against an unemployment rate pushing eight per cent. <br /><br />That said, stocks might look expensive now, but solid earnings reports this month, along with low bond yields and a lack of nasty surprises in the commodities markets might persuade that sideline cash to take one punt at the rally before Christmas.<br /><br />Martin Baccardax is On-Air Economics Editor at CNBC and co-host of Closing Bell and Europe Tonight