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The financial markets' enthusiastic about-face on a bit of positive news is emblematic of the growing debate dividing investors: Without more stimulus help from policy makers, will the economy have enough juice to sustain the bull market?

After weeks of answering that question with grave doubts, investors were buoyed Tuesday by better-than-expected retail sales data out of the United States and encouraging industrial-production numbers from China.

The renewed hopes for the U.S. consumer and the Chinese economic engine - both critical elements to the global economic recovery - sent commodity prices higher and propelled the Toronto Stock Exchange's S&P/TSX composite index to a 158-point gain, its best day in nearly a month, reversing Monday's 144-point drop.

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In New York, the Dow Jones industrial average surged to a triple-digit gain, while the S&P 500 index jumped 1.3 per cent, its best day since mid-April. Most major overseas markets also enjoyed gains of more than 1 per cent.

While Tuesday's surge was only the second gain in the past 11 trading days for the TSX, it did suggest that a strong base of investors believes the economy is emerging from its doldrums.

But the two weeks of heavy selling that preceded Tuesday's bounce show that the optimists face a struggle to overcome a powerful faction of pessimists, who see the market running on empty as the U.S. and global economies falter and the U.S. Federal Reserve Board prepares to take away a crutch that many believe held up the market rally.

Driven by Stimulus

Those fears have been heightened since June 7, when Fed chairman Ben Bernanke gave a speech that suggested the central bank won't launch a third round of quantitative easing - its asset-purchase program aimed at injecting money into the financial system - once its current second round (dubbed QE2) expires at the end of June.

"Beyond government stimulus, there's not a lot of growth in the world," said Larry Berman, chief investment officer at ETF Capital Management.

Indeed, Mr. Bernanke's speech sent stocks tumbling and bonds rallying - a signal from the markets that the Fed needs to reconsider. Some prominent voices, including investing legend Jim Rogers, have said they believe there's still another round of quantitative easing - QE3 - to come from the Fed.

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"There can be little doubt that QE2 has boosted the stock market," wrote senior market economist John Higgins of London-based Capital Economics.

"Should the flow of cheap money start to dry up, there is a concern that the 'risk-off' trade could spark an extended correction," said Steven Ricchiuto, chief economist at Mizuho Securities USA Inc. in New York, in a note to clients last week.

What Weakness?

Yet many economists argue that the U.S. economic recovery is doing fine without further help from the Fed, and that the apparent recent weakness in the economic data is temporary and deceiving.

"The fact that data surprises are worse than last year, while business conditions remain generally similar to last year, suggests that this is a case of expectations getting ahead of themselves more than a complete data meltdown," wrote Pierre Lapointe and Alex Bellefleur of Brockhouse Cooper in Montreal in a report this week.

Economists noted that QE2 was put in place to add much-needed liquidity to the financial system and combat the threat of deflation - problems that have faded considerably under QE2.

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"Judging by money supply trends, there is plenty of money in the system," said Brian Belski, chief investment officer at Oppenheimer & Co. Inc. in New York. "Even if the Fed does not inject any more money into the system, that shouldn't mean stocks will suffer long term."

"Rather, we believe that a general lack of sustainable confidence has held back the U.S. economy and stock market," he said. "Investors will eventually need to recognize that the markets and economy do not necessarily require historically low interest rates and a weak dollar to continue to grow."

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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