Why Aren't Stocks Falling?

As SAR notes, the "longer and deeper recession" meme is "becoming the popular view" -- it's increasingly difficult to find people who really think we'll bounce back in the second half of this year, and economists generally are much more bearish now than they were a couple of months ago.

So why is the stock market up 20% since then?

My feeling, mainstream as it may be, is that stocks are drifting upwards in blissful ignorance of reality, much as they did for nearly all of 2007, even after the credit crisis first hit. The panic sellers and the people desperately needing liquidity have left, volumes have fallen (as they always do around the holidays, no news there), and volatility has decreased. And so both value and momentum players are feeling increasingly comfortable rotating back in to the market.

But if the recession gets to be as bad as people are increasingly expecting, fundamentals will eventually start asserting themselves -- and if we're unlucky, they'll do so in a violent downward manner, much as they did last fall. Remember that the bond market is pricing in a serious wave of defaults -- and I don't think the stock market is. If and when those defaults arrive, with shareholders of the companies in question being largely wiped out, will the broader indices really remain unaffected? And more generally, a two-year-long recession does really nasty things for corporate profits, which rise much faster than GDP in boom years, but fall much faster than GDP in bust years.

The lesson of the past two years is that the stock market is a lagging, not a leading, indicator. I have no faith in this rally whatsoever; I hope that I'm wrong, but I just don't see the current stock market reflecting an economy which is hugely reliant on retail spending and where holiday-season sales were the weakest in four decades. It's always calmest before the storm, and I fear another gale might be brewing.

Comments

[herbert hoover:]

Reality trumps hope every time. It's gonna get ugly - fast.

Jan 08 12:11 PM

[waf76:]

Well the calm we're experiencing is this transition period from Bush to Obama but can the stock market dip lower, yes I agree, and expect us to retest the lows of November 20th at some point in the 1Q. We will remain in this trading range for a while until we see some sort of real breakout in either direction. I hope we do not make new lows but we'll see. I would have to disagree about the stock market being a lagging indicator rather than a leading one. I think it has more to do with the efficient market theory. If anything, it is highly inefficient and we cannot trust it to be a leading indicator.

Jan 08 12:50 PM

[driftwood2:]

Historically, the stock market has been a leading indicator. I agree with the OP and have myself noticed that the market has ceased being a leading indicator for a few years now.

I expect new market lows this year. This really is the "Great Depression 2" we're in.

Jan 08 02:50 PM

[Echo To All:]

Felix, imo, ur a good financial journalist, but have a poor grip on market dynamics. Looking back at the data recessionary conditions were present over a year ago. And guess what, the market went down before that data appropriately showed how bad things were. (ie a leading indicator)

The market is up 20% from its lows because we had stocks like GOOG at level not justifiable.

Whatever your thinking on the market technicals, leave it for the traders because your concept of the market is wrong. But keep being a journalist, imo ur really good at it.

Jan 08 03:08 PM

[Robert Ivan:]

"stocks are drifting upwards in blissful ignorance of reality" I also see no reason for stocks to be rising as a whole at this point. I'm stockpiling cash for another pullback. Would you believe I'm up right now in GE, ABB, and PFE? crazy world ...

Jan 08 04:34 PM

[Slick Rick:]

Let's all recognize one important fact-markets and stocks don't rise on the facts of great earnings and seemingly solid performance. If that were the case then all an investor would have to do is find companies that continually make great earnings and presto mo money mo money.

But as any novice investor knows who has fallen into this fundamentals trap its not that easy. The dot com bust even thought it ended poorly proved that financial institutions are perfectly willing to BUY regardless of current proven information. I hate to say buy the rumour sell the fact here, but this is the single head fake that leaves the average investor scratching their heads. Will the market plummet? perhaps. But if you're a fund manager and don't want to see, outsmarted by your fellow risk takers in the next 12 to 18 months, then some buying has to take place under the support of a new administration that the global community sees as the biggest bullish signal since Google went publc. Besides at some point we're going to need inflation to be triggered by something.

Slick Rick


On Jan 08 12:11 PM Herbert Hoover wrote:

> Reality trumps hope every time. It's gonna get ugly - fast.

Jan 08 05:00 PM

[debtacid:]

Clearly, the Fed puppet masters are the only thing keeping this zombie market going. They are holding it up by the wrists but soon the arms are going to fall off.

Jan 08 05:44 PM

[John Lounsbury:]

The market is a leading indicator in that it oftens goes up 3-6 months before a recession ends and down before a recession starts. However, it also usually has rallies before the final "indicator" rally and pull backs before the final "indicator" decline. You can make a lot of mistakes before you catch the "indicator" move.

My answer to why the market is levitating - De Nile is a deep river.

Jan 09 12:30 AM

[Steven Hansen:]

the market is levitating because there is a lot of money out there sitting in funds / sidelines - and it is not working. this pressure is keeping the market up. this is a real upward fundamental.

there is no where to put money to work.

i am happy the market is not hoping around like an indian walking on fire.

Jan 09 02:26 AM

[Smarty_Pants:]

If there's one thing I've learned from the numerous mistakes I've made in the market, it's that trying to figure out why the market is doing something is not of much use.

What is of use is observing the market do something and then act based on what is happening. Right now, the market is rangebound. Why? I don't know, but it is. When it breaks out of its trading range and moves one way or the other something can be done to take advantage of the situation.

Until then, the best you can do is sit and wait. Patience is a virtue, and often profitable.

That being said, it can be informative to think about existing conditions or expected changes and how the market might react, which is what Felix is doing. It can be very helpful for identifying what actions you might want to take AFTER the market 'does something'.

Think, develop various contingency plans, WAIT, observe, react.

Jan 09 10:00 AM

[momomiester:]

Market is as dumb as the day is long. I think much of the move it is a results of momentum. Stocks got oversole short-term and managers will go with the flow and buy due to they are paid on performance. Also, they will justifiy the investment with the assumption that the stocks are cheap in their eyes..
Back in 07 the markets totally didn't see this coming. They assumed that it was normal for a 8 buck an hour worker to be able to buy a 700k home with no money down. That there would be no fall out from this yet back in 2000 there was a huge fallout from people daytrading their speculative money in net stocks. This time they were speculating with no money using 100x the leverage...Yeah markets always get it right.

Jan 09 03:07 PM