Wanted: Duller times for stocks

(breakingviews.com) -- Financial excitement has been in ample supply for ages. The second quarter of 2009 was no exception. Investors should hope that the dramatic rise in most of the world's stock markets in the period -- 15% or so in Europe and the U.S., almost 20% in Japan and more than 50% in some emerging markets -- marks the end of the thrills.

Equities rallied because the world averted financial catastrophe. The authorities' heroic efforts gave investors good reason to stop worrying about meltdown -- and plenty of money to move markets.

But the rally has not healed the scars left by the financial crisis. In dollar terms, world stock prices are still 36% below the level a year ago, according to Société Générale. The credit market's scars are deeper. The 106 basis point spread on Markit's index of European investment-grade debt narrowed from 174bps in the quarter, but is up from just 10bps two years ago.

Debt buyers are still counting on a severe recession. Yet stocks seem to be looking towards normal economic times. The multiple on recession-devastated 2009 earnings is 15.6, according to SocGen.

That's far above the bargain basement levels that prevail when catastrophe looms. It falls to 12.2 for expected 2010 earnings, which looks better value. But there must be considerable uncertainty over the pace of any earnings recovery.

The stock-market excitement has petered out in the last few weeks. Equity investors' hope should be that the ennui continues until the economic news catches up with the rally. More excitement -- in either direction -- could be dangerous.

With a solid recovery already priced in, another big jump in shares over the next few months would probably be a sign that stimulus programs have spawned another asset-price bubble. That could have disastrous consequences later.

If all goes according to the authorities' plans, the wall of cheap money should prevent equities collapsing. But the crisis could still take another turn for the worse, say through a major government failing to raise debt or a sudden lurch in inflation. No amount of free money could absorb such a shock. It would be exciting, yes. But investors could end up devastated.