What Will Move The Market?
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What Will Move The Market?
By Scott Shaw
Frustration abounds these days. The economy is improving, forward looking fundamentals are as good as they have ever been, yet the stock market, slowly, like Chinese water torture, continues its slide. Rallies create false hope, only to see the next down turn even lower. Lower highs and lower lows seems the order of the day. But in the end, stock prices follow profits and economic conditions, and the economy is as described below”
"We're pounding the tables emphatically with the message, 'THE UPTURN IN THE ECONOMY HAS OCCURRED,'" says Lakshman Achuthan, managing director of the Economic Cycle Research Institute. IT is a significant piece of the economy, and it can't escape these economic cycles.”
It is enough to make me want to get up and just literally scream! “The economy is improving, valuations in many of the world’s leading companies, in industries with enormous growth potential over the coming decade are selling cheaply, and yet you continue to sell on good news and bad!”
One explanation for this is what psychologists and marketers call the “Recency Effect.” That a person’s most vivid memory is that of the most recent dramatic events, and a person’s recall of these more recent events overstates their relative importance or size. The recent cyclical downturn in technology is a recent phenomenon and stuck in most peoples’ brains as if these doldrums will last forever. I mentioned this in a prior column, but if you remember back, the 1980s started out with the deepest recession since the Great Depression; the 1990s started out with a recession deep enough to knock off a war hero president; yet both the 1980s and 1990s turned into the two most successful economic decades in American history. The 2000s are starting off in a similar pattern. No one can say whether or not the 2000s will achieve similar economic success, but the groundwork is there for the 2000s to at least repeat the same success of the 80s and 90s, if not exceed it. What is overlooked is the historical precedent that economic downturns, when inflation is low, interest rates are low, monetary policy is easy, productivity is at record levels, consumer spending is strong, free trade is the rule in most of the world, demographics are at their peak as baby boomers move into their peak earnings and spending years, and new mass market product categories (electricity, car, computer, telephone) are in their early phases of deployment, is that economic downturns turn into strong economic recoveries. That, in fact, periods of recovery are usually far longer than periods of economic downturn. But don’t let this sort of long-term thinking get in the way of the Recency Effect.
Forbes magazine in the June 10, 2002, issue provided evidence in this regard when the author James Grant discussed the subject of hedge funds and how hedge funds were making their way into the grocery store. Mr. Grant explains: “When things like hedge funds actually acquire a mass market following, some kind of disaster is just around the corner.” Or, and this seems eerily reminiscent of say 2000, except substitute “long” and “going up”: “It is an open secret among seasoned bears that only a small fraction of short sales these days are the result of rigorous and original securities analysis. Nowadays more and more shares are sold for no better reason than that "the market is going down."
The economic upturn I’ve written about in several columns is occurring and the evidence is strong that it will continue to occur. It won’t be a return to 1999, but given the low valuation levels of many stocks and extreme pessimism that exists in the marketplace today, when the turnaround gets into full swing, say by the 3rd and 4th quarters of this year and first quarter of next year, there exists the real possibility of some very nice stock appreciation as irrational pessimism, which as exampled by the hedge fund example, is reaching absurd proportions, is turned around by the mother of all short coverings as earnings continue to improve, and visibility returns.
Unlike in normal economic recoveries, however, it seems likely that the stock market, instead of being a leading indicator, will in this recovery be a lagging indicator. This is because: (1) the above Recency Effect will take some time to turn around, and (2) the perceived increased risk in the world. The United States is at war with terrorism (the war is currently in a state not too much different from the lull that occurred shortly after the outbreak of World War II in Britain), the Middle East is a powder keg with oil supplies at potential risk, and India and Pakistan are yet again lining up for a major border dispute. These risks are not going to dissipate any time soon. So what is the average institutional investor to do? (1) Sell everything short because everything is going down anyways, (2) Buy gold until its price level is pushed to absurd levels, and (3) Jump out of short positions and gold with a vengeance when Cisco reports and increases its forward guidance.
In conclusion, economic fundamentals and valuations are in place to support a return of a bullish market over the next few years. Unlike in normal periods of time, the stock market may in this period of time turn out to actually be a lagging indicator, as the herd mentality reaches epic proportions, as hedge funds become sold like mutual funds at grocery stores, stocks are sold short just because everything is going down, and money rushes into gold pushing gold up to untenable levels. It is like a cork in a bottle, a cork that will explode with a mass exodus out of these positions when Cisco raises their forward-looking guidance. Absent another major terrorist attack, oil price shock (which looks much less likely now, particularly with Russia coming on-line as a major producer), or a realistic threat of use of nuclear weapons in Kashmir, the cork popping sometime in the next 9 months seems almost inevitable, at least at some point in time. (The Pakistan/Indian war is really a border dispute and not a fight for national survival, much like their previous disputes, as was the USSR/Chinese border conflict of 1969. Border disputes are not likely to rise to the level of a nuclear dispute, unlike say total war for national survival might.)
Still, given these uncertainties, until then I can understand why so many people want to keep their money anywhere but the market. It is a cliché, but that is also precisely the time when the largest profits are made, at the points of maximum irrational pessimism (long), or maximum irrational optimism (short). I think the only sensible way is to strike a balance as to where you put your money (in and out of the market) is with this very real risk in mind, but balanced against what is demonstrably becoming a mania on the short side – a mania that will break with a vengeance as evidence of economic recovery and future expansion is everywhere. All it will take is a company like Cisco raising forward guidance and saying the words “visibility is good.” The momentum out of the short side mania will be unstoppable. |
