http://www.theglobeandmail.com/report-on-business/economy/economy-lab/david-rosenberg/whats-driving-the-us-stock-market-higher-wishful-thinking/article1746401/

Five ideas are driving the U.S. stock market higher right now. In each case, I think investors are wrong. Let me explain why.

No double dip: The consensus view is that the United States is safely out of recessionary territory. This seems wildly unrealistic to me.

The principal driver of economic growth in the third quarter was a 30-per-cent annualized surge in auto production from depressed lows. The boom in car sales added about 1.5 percentage points to the economy’s growth during the quarter. Given that the entire economy likely expanded at an overall annual rate of 1 to 2 per cent, pretty well all the gross-domestic-product gains came from the auto sector.

I expect the automotive contribution to GDP growth to reverse course in the fourth quarter as cash-strapped consumers sit on their wallets. Meanwhile, real final sales growth across the entire economy is running at a mere 0.8-per-cent annual rate. Factor in dwindling fiscal stimulus on the part of government and an end to the inventory-rebuilding cycle, and the U.S. economy is likely to contract 0.9 per cent next year, barring some major new round of stimulus.

Strong corporate earnings:Analysts are predicting the S&P 500 will produce earnings of $95 (U.S.) a share in 2011, a 14-per-cent gain over this year. The problem with this rosy view is that the economy is no longer accelerating. It is decelerating.

To hit $95 in earnings, nominal GDP would have to grow at least 7 per cent, a feat that last occurred in 1989, or profit margins would have to reach new record highs, which from this point appears implausible given their current high levels already. I give either scenario 1-in-25 odds of occurring. My forecasting model calls for $75 a share in S&P earnings next year.

Assuming a price-to-earnings ratio of 10 – consistent with the prevailing economic uncertainty – it’s not at all out of the question that the S&P 500 could fall to 750 at some point, down a third from current levels.

Stable U.S. home prices: I have no clue where this notion comes from, but it seems to have become conventional wisdom. If anything, we are in the process of seeing another leg down in U.S. home prices.

Median new home prices fell 0.6 per cent in August and are down now in each of the past three months and in four of the past five. Nearly five million homes and condos are listed for sale, double what was typical of the housing boom years. Two million of the housing units for sale are sitting empty, while another 3.7 million vacant units are being held off the market for unspecified reasons.

Given this massive overhang of inventory, U.S. home prices are likely to decline at least another 10 per cent from current levels. The reality is that the excess supply of homes is bigger now than it was at the depths of the real estate collapse two years ago.

The U.S. midterm elections will change everything: There seems to be tremendous enthusiasm that the U.S. congressional elections on Nov. 2will unleash dramatic political change. These hopes are greatly exaggerated.

First, while it is a no-brainer that Republicans will make gains, it is still not clear that the GOP will take control of the House of Representatives, let alone the Senate. Second, it’s anyone’s guess how U.S. President Barack Obama will respond, even if the Republicans do win control. He could choose to be conciliatory or he could adopt a more aggressive stance, leading to political gridlock.

A presidential election is still two years away. And it is going to take time for any leader to expunge the lingering effects of the credit bubble. Ronald Reagan was a transformational figure, but the equity market did not end its secular bear phase for a good two years after the Gipper won his first election.

QE2 is coming, and it will work: Investors are pinning hopes on another round of quantitative easing by the U.S. Federal Reserve Board. With quantitative easing, the central bank would create money and use it to buy securities – probably 10-year U.S. Treasuries – just as it did last year.

The point of quantitative easing is to drive up prices on those securities and drive down yields and interest rates, which move in the opposite direction to prices. Lower interest rates would help the economy and the stock market, or so the theory goes.

But there is dissent at the Fed over another round of quantitative easing. While some of the presidents of regional Federal Reserve Banks have voiced support for the policy, others, such as Richard Fisher of the Federal Reserve Bank of Dallas and Thomas Hoenig of the Federal Reserve Bank of Kansas City, are skeptical.

In other words, a second round of quantitative easing – QE2, as it’s called – is far from a done deal. Even if it does occur, it’s not clear what it would accomplish. It might reduce the yield on 10-year Treasuries by another 50 to 75 basis points (a basis point is one hundredth of a percentage point). Yet the 10-year yield has already fallen nearly 300 basis points over the past couple of years with little result.

My view is that the U.S. economy and the U.S. stock market face substantial risks. Next time you hear someone spout one of the five ideas listed here, realize that there is another side to the story.