BETTER BE BULLISH

The Federal Reserve’s plans for broader recovery depend on stocks continuing to tick higher.

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

But when Fed Chairman Ben Bernanke was asked recently on Capitol Hill about the market’s outlook, 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 mas- sive 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.

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.

BULL MARKET

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 percent of U.S. households by income account for 38 percent of consumer spending.

For now, the bull market still appears to be on strong footing. 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.

With major U.S. stock indexes at or near all-time highs, market bulls face the challenge of convincing 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 longlasting, such as the 1990s rally.

“I think the whole game plan of the Fed is to give people that assumption” about a new secular bull run, said Robert Dohmen, head of Dohmen Capital Research in Los Angeles.

That doesn’t mean the Fed would sweat a normal “correction” in stocks that might temporarily shave 10 percent or so off prices. But another bear market any time soon — a drop of 20 percent or more — could be too big a shock for the economy to handle, some analysts say.

Yet the Fed’s program of printing trillions of dollars since 2008 to buy bonds as a way to suppress interest rates also has revived criticism that policymakers have become blatant market manipulators — a de facto “plunge protection team,” a term coined after the 1987 stock market crash.

Bernanke has heard those allegations many times, but still bristled during his testimony last month when Sen. Bob Corker, RTenn., accused the Fed of creating a “sort of faux wealth effect” by helping to drive interest rates down and stocks up.

Bernanke denied that, saying the central bank was trying to fuel “a genuine increase in wealth” by stimulating the economy and boosting entrepreneurial activity.

That’s a hard sell for some individual investors, including 78-year-old Mike Celeste, who says he gave up on long-term stock investing more than a decade ago and has since just focused on short-term trading. Celeste worries about the effect on markets when interest rates finally rise.

“How long can they continue to have a false interest rate?” he said of the Fed’s benchmark short-term rate, now 0.25 percent.

GLOBAL ECONOMY

Some economists say the greater threat to stocks isn’t that rates will rise soon, but that the global economy will continue to struggle, weighed down by the burden of debt taken on in the boom era of 1983 to 2007. That raises the risk that corporate sales and earnings growth will stall, which could pull the rug out from under equity prices.

The Eurozone and Japan both are back in recession, and the British economy also contracted in the fourth quarter. The U.S. economy barely grew last quarter, advancing at a 0.1 percent annualized rate, and now faces automatic federal spending cuts under the budget sequestration mandate.

Growth also has slowed in much of the developing world, including Brazil, Poland and South Korea.

“Where is the growth going to come from?” to drive earnings, Ricchiuto of Mizuho Securities asked skeptically.

But recent reports have pointed to surprising strength in the U. S. economy this year. New home sales jumped to an annual rate of 437,000 units in January, well above estimates and the highest since July 2008. And an index of U.S. manufacturing activity rose in February to the highest level since June 2011.

Even if the economy posts anemic growth in the near term, Wall Street bulls are betting that a combination of three major market shifts — and some luck — could keep stocks aloft. The shifts:

Stock price-to-earnings ratios rise: Simply put, this means investors would be willing to pay a higher share price for the same amount of a company’s underlying earnings.

“The main case for the equity market is valuation,” said Ethan Harris, co-head of global economics research at Bank of America Merrill Lynch in New York. And if investors believe that global growth will pick up in 2014, as Harris does, it could be easier for them to justify getting into the stock market now or boosting their bets.

Fatter dividend payments attract investors: The corporate earnings boom since 2009 has powered a surge in dividend increases by companies large and small. Total dividends paid by the S&P 500 companies reached a record $281 billion last year.

Money shifts from bonds to stocks: Millions of investors have sought refuge in bonds over the past five years — a smart move as central banks have continued to push down market interest rates, rewarding those who locked in higher yields.

WHAT’S NEXT?

With yields now so low, the Fed and other central banks want to see confidence continue to blossom among the ranks of investors — confidence the market is not about to go into a tailspin.

A crucial next step, Pimco’s El-Erian said, would be for rising confidence to boost spending by wealthy consumers worldwide, the middle class of the developing world and financially robust companies. “There are a lot of healthy balance sheets around the world,” he said.

With the stakes so high, ElErian and Harris see no chance that the Fed and other major central banks will pull back from providing whatever financial support they can to the markets and the economy, despite the risk of eventually creating new asset bubbles or fueling inflation.

The end of the Fed’s moneyprinting campaign “is nowhere in sight,” Harris said. “It keeps bond yields low and the stock market up.”