Why Do Equity Markets Disagree with the Data?

Some of the smartest economists, traders, bankers, brokers, and academics are all screaming and yelling the same things: "This recession/depression is NOT over yet! This is just bear market rally! There are NO green shoots!"

And the data does support these beliefs. Retail sales and consumer spending remain muted as families increase savings and pay down debts.

Unemployment is not yet recovering, foreclosures are still rising while home prices are still falling. Commercial real estate is starting to falter in a major way. Oil and metals remain elevated while the dollar remains relatively weak. Banks are failing at a record pace and the FDIC is on the verge of insolvency. The government is auctioning debt at a record pace (and record % of GDP) while the deficit explodes. Banks are still NOT lending to small businesses or homebuyers nor to each other. Much of this data is also showing no sign of decelerating. Every week a new number comes out the revision for the previous always seems to go worse!

And the GDP numbers, when analyzed, show that government spending and issuance of government debt is keeping the economy from being much much worse. And what happens when BRIC countries stop buying our debt and dollars? The Ponzi scheme falls apart then? And what about diminished tax rolls both local and federal due to low employment and low corporate earnings!?

On these points nearly everybody agrees - the numbers don't lie and this is what has been and is going on right now. And yet the major stock market indices continue their march upward... not even sideways but upward indeed!

So, why do the equity markets seem to disagree with the data? What conclusions are the markets drawing, where many people including myself cannot seem to connect the same dots? Perhaps it was the the weakening dollar is causing inflation which would produce higher stock market prices (but not necessarily higher market VALUES). However CPI, PPI and other data suggest that inflation is nowhere to be seen (except maybe at the pump or the supermarket). So that can't be it. Right now the S&P 500 index is trading at a higher implied P/E than it has seen in ages! Maybe a record.. and this is when the consumer isn't spending!?

Even the credit markets don't entirely agree with what is going on in the equity markets - there is still a big disconnect, and generally speaking the credit market are the "smart guys," right?

Is this all just a gigantic short squeeze? The rally seems too widespread, intense, and prolonged for a squeeze which is generally a short-lived spike of panic and covering.

So please, share your insight. Because I am at a loss.

Comments

[Adam Hayes:]

well if those people (the huge sideline money guys) are so smart, won't they lose their return when they buy high up here and then sell out lower on the "coming downturn"..


On Aug 20 05:23 PM ipesq wrote:

> It is not rational. The markets should be (and ultimately will be)
> heading strongly down. Question is when. Only explanations I have
> for the continued advance to this point are huge sideline money in
> cash getting no return and seeing stocks advancing along with emerging
> markets actually growing and creating demand.

Aug 21 08:52 AM

[Adam Hayes:]

Sure, I agree overall volumes are low and at the same time high-frequency and algorithmic trading has taken up much of the slack. The thing is though, that the HFT computers don't really care if the market is going up or down, they can make money in any environment by trading in and out of real order flow and trading baskets against ETFs/Indexes in milliseconds..


On Aug 20 05:25 PM Dave Wrixon wrote:

> This might be a sustainable argument if volumes were what you would
> expect during a rally. When the market are rallying on light volume
> you can only assume they are being subject to manipulation.

Aug 21 08:54 AM

[Adam Hayes:]

I'm a reader of ZH and even TD can't explain the sustained rally.. he and his crew are constantly posting stories and data analyses that are consistent with my view.. but agreed it is a valuable resource amongst many - and note as I said in a previous reply, I agree that HFT and algorithmic computerized trading systems CAN and DO manipulate markets, but they do NOT care about direction and cannot prop up a failed market for perpetuity. I remember in my Econ101 class in college the professor said: "Nobody or no thing is bigger than the market". Ive heard it time and time again and time and time again this credo has proven true.


On Aug 20 05:36 PM Econpro wrote:

> Bingo...pure manipulation....if you haven' t discovered zerohedge.com...time
> to head that way and all your questions on how this market can keep
> going up despite all you have mentioned will be answered....BTW tell
> your friends about ZH too....best site on the web

Aug 21 08:58 AM

[Adam Hayes:]

Agreed. That's why I wrote this in order to flush out that gem of information!


On Aug 20 06:23 PM Roger Knights wrote:

> Here's a gem from one of Steven Hansen's recent articles on SA:<br/>
>
> "An old professor once told me when you do not understand something,
> there is something you do not know."

Aug 21 08:59 AM

[Adam Hayes:]

There's a couple problems with your solution: First, treasury sales (auctions) have not really been spectacular in general. Sure on a few occasions the bid to cover was large and all sold on target. But on others here (and in UK and Europe and Asia!) gov't debt auctions were met poorly.
Second, a the ratio of foreign money buying our treasuries has declined replaced by the gov't itself!!! (the Fed!! - monetizing debt) and by gov't backstopped large banks. -- And why would a large bank buy tons of treasuries yiedling 0.15%? That's basically zero after fees and transaction costs. Well i dont know why but it's scary cuz they aren't selling equities to buy treasuries (yet).
Third - deflation and declining prices is a negative pressure on stocks for a number of reasons. Fundamentally, companies have to lower prices = lower sales = lower profit and larger inventories. Additionally in macro terms, if you have a stronger dollar (weaker prices) then to preserve the same VALUE a stock that traded $100 last year with deflation at say 3% that stock would have to be $97 today to retain the same VALUE.
Fourth- if interest rates rise, bond prices go down. If you're right and interest rates go on a steady march higher, buyers of bonds will get reamed.

On Aug 20 07:27 PM Roger Knights wrote:

> OK, I've got it. It's interest rates. Somehow, incredibly, sales
> of Treasuries have held up, despite the low interest rates they're
> paying. QE, plus international cooperation, plus a flight to safety,
> plus deflationary trends, are all behind this high price. But when
> interest rates rise, possibly at the same time the artificial support
> of QE ends, then money will flow out of stocks and into bonds, and
> stocks will tank.

Aug 21 09:07 AM

[Adam Hayes:]

I like this idea.. it is certainly a novel twist, however I find it strange to have such a focused inflation when the overall deflationary environment will fundamentally kill earnings by forcing lower consumer and producer prices... and if the overall economy is seeing price reductions, well then the dollar should be getting stronger fundamentally by extrapolation (i.e. the same number of dollars can now buy more and more stuff) -- maybe that stuff they choose to buy is equities and commodities? seems like a merry-go-round and a catch-22... but may be a very interesting feedback loop.. we shall have to see if this continues... Thanks for the idea!
-Adam


On Aug 21 12:34 AM Lawrence J. Kramer wrote:


> We have inflation in financial instruments - too much money chasing
> too little paper. So everything "goes up," and stays up until supply
> catches up. But supply won't catch up; no one wants to issue paper
> when no one will buy the goods the issuer would use the proceeds
> to produce. (When else has a bull market produced so little IPO activity?)

Aug 21 09:21 AM

[Adam Hayes:]

So what happens whenever the paradigm shifts back to profit growth, 5% unemployment and steady housing data? To the moon?!

> However, no matter which 3 reasons it is, I guess it's fair to say
> that the market's rise doesn't seem to be betting on a traditional
> recovery in any sense of the word and doesn't care or even expect
> housing or employment to improve. Sorry to ruin readers day with
> such a dour assessment to a otherwise happy equity run-up.

Aug 21 09:24 AM

[History Buf...:]

The rally that kicked this off back in March was manufactured, as it continues it continues to be manufactured. This has multiple purposes:

GS can continue to make money with their program trades which make money whether the market is going up or down, they just need volume to run the trades.

They can continue to fleece the retail investors who don't know the entry and exit points and will inevitably get burned again (but minus the billions and billions of dollars they tossed in which will be in the pockets of the manipulators)

They can continue to squeeze the shorts. Since they WERE the shorts in the run up to this crisis and will probably be the shorts again when they squeeze all the other players out, this is of course breathtaking hypocrisy. My guess is they don't like the competition. This is like the mafia running the small time drug dealers out of town.

The ongoing demonization of short sellers and scapegoating is ridiculous, they need to enforce a ban on short selling in all markets, covered shorts has never been a problem and is still not a problem.

The problem is not rational markets vs. irrational markets. This market is being manipulated. We're looking at 1930 here, not 1982. This is not the beginning of a new bull market, this is just a teaser in a multi year depression market.

Aug 21 10:31 AM

[Suncatcher:]

I agree with almost all of your article...except: the FDIC being almost insolvent. If the FDIC is almost insolvent then you are, by extension, saying the federal government is thus so. I think the monetary policies of our country are bad, bad, bad, but we haven't yet achieved insolvency. If the appearances can be maintained they may yet pull this off.

Aug 21 12:23 PM

[puravidavid...:]

Adam, "Why do equity markets disagree with the data?" Because, as with all else, form follows function. The function of markets is to separate outsiders from their money for the enrichment of insiders.

That being, wave form and technical analysts have reasonable confidence that the markets are simply tracing out their logical patterns with the mood swing. Averages have retraced in time and distance with Fibonacci ratios. This primary wave is near the trend's end and will reverse with bearish ferocity.

Sentiment has grown to near 90% bullish and I'm claustraphobic.
The herd has never, ever anticipated trend changes, but rather piles in near tops and refuses to buy when a real bottom has been reached.

Once again the market is dominated by the prerational-brain-stem instinct to herd. Once again, the shepherds (wolves) inside the pasture paddocks shear and eat the lambs and sheep who enter in.

Aug 21 01:04 PM

[Suncatcher:]

Puravid@yahoo, It seems you are an advocate of Elliott Wave Theory. As a new hands-on investor I discovered the Elliott Wave recently and have been swept up in it. I must admit some significant unease though when I read EWI analysis they always leave themselves a fairly large trapdoor to still be "right" even if their analysis is incorrect. When trying to trade in real time it has to take nerves of steel to stay the course when the market is kicking you in the teeth (like the last couple of days). I am staying the course for the moment but if this horse throws me I don't know if I'll be able to re-saddle.
How do you do it?


On Aug 21 01:04 PM [e-mail] wrote:

> Adam, "Why do equity markets disagree with the data?" Because, as
> with all else, form follows function. The function of markets is
> to separate outsiders from their money for the enrichment of insiders.
>
>
> That being, wave form and technical analysts have reasonable confidence
> that the markets are simply tracing out their logical patterns with
> the mood swing. Averages have retraced in time and distance with
> Fibonacci ratios. This primary wave is near the trend's end and will
> reverse with bearish ferocity.
>
> Sentiment has grown to near 90% bullish and I'm claustraphobic.
>
> The herd has never, ever anticipated trend changes, but rather piles
> in near tops and refuses to buy when a real bottom has been reached.
>
>
> Once again the market is dominated by the prerational-brain-stem
> instinct to herd. Once again, the shepherds (wolves) inside the pasture
> paddocks shear and eat the lambs and sheep who enter in.

Aug 21 01:27 PM

[puravidavid...:]

I've been a cool, calm contrarian since the mid 1970s. I trust my eyes when I look at charts.

Third waves of minor degree (days) or higher are always money makers. The rest of the time, I'm largely in treasuries and cash.

Currently I've been $ cost averaging into SDS and don't mind being down a few percent, I know where the larger degree of trend will put me over the next months and years.

Yes, EWI hedges their bets and point to retracement levels as markers. They have also been early anticipating pull backs. Still, they've spotted trend changes with better forecasting skills than others I've monitored over many years.

Caveat emptor and happy speculating!

Aug 21 02:11 PM

[jeffgroove:]

when bad money chases out good, it has to go somewhere, and it may as well be the stock market. Ask yourself, given the general outlook and pardon me for invoking peter schiff, would you really want to be in dollars? Granted, I do not really believe the great chinese miracle that is going to bring great wealth and prosperity as he professes.

Aug 21 02:32 PM

[snakyjake:]

We know the government is going to prevent any sort of crash, either through borrowing or printing money.

I think we're seeing the stock market prices rise because there's a lot of global currency out there. Inflation is seen in the markets.

Savings and Treasuries have too low of yields to be attractive (at least to me).

People putting their money in the market in order to hedge against inflation.

Aug 21 02:34 PM

[puravidavid...:]

velocity, price and output, too.


On Aug 20 06:18 PM The Geoffster wrote:

> Liquidity, liquidity, liquidity.

Aug 21 05:26 PM

[puravidavid...:]

Over time it's a barometer, a trend and extreme range indicator; instantaneously it's a thermometer of socio-economic temperature.


On Aug 20 07:03 PM Sirroyce wrote:

> The market, as John Train has written in The Craft of Investing,
> is a barometer..not a thermometer.

Aug 21 05:30 PM

[puravidavid...:]

"rally" is also due to low volumes and circular institutional trades that amount to nothing but transaction fees and higher prices for market makers. Legal manipulation, simply put.


On Aug 20 05:23 PM ipesq wrote:

> It is not rational. The markets should be (and ultimately will be)
> heading strongly down. Question is when. Only explanations I have
> for the continued advance to this point are huge sideline money in
> cash getting no return and seeing stocks advancing along with emerging
> markets actually growing and creating demand.

Aug 21 05:34 PM

[puravidavid...:]

It changes when the Crises reaches the foundation of security: food, clothing, and shelter. At that order of magnitude the herd can become a hord, armed and dangerous.


On Aug 20 07:27 PM untrusting investor wrote:

> Yes, you are pretty close to the mark on how it really does work.
> Just not sure much can be done about it short of a mass uprising
> similar to a French Revolution type event or literally a military
> coup. The politicans and a small wealthy elite have virtually unlimited
> resources, mass media control, legal control, and every other advantage
> that one just cannot envision how it will ever change for the average
> American.

Aug 21 05:40 PM

[puravidavid...:]

Chinese miracle? With one child policy they have a shortage of future workers per retiree, a shortage of brides for one-quarter of their male population, and a grand misallocation of assets via unwise and corrupt central planning. Some miracle. Schiff can be taken lightly and skeptically.


On Aug 21 02:32 PM jeffgroove wrote:

> when bad money chases out good, it has to go somewhere, and it may
> as well be the stock market. Ask yourself, given the general outlook
> and pardon me for invoking peter schiff, would you really want to
> be in dollars? Granted, I do not really believe the great chinese
> miracle that is going to bring great wealth and prosperity as he
> professes.

Aug 21 07:13 PM

[Brian McMorris:]

Puravidavid.....where do you get your numbers on sentiment? They are wrong and proven so by the market to be wrong. I normally like your take on the market and your historically informed opinions. But you need to reconsider.

AAII has the sentiment last week as 34% bullish, down from 51% the prior week. All the other sentiment indicators reported on Barrons are also down from prior weeks. This explains the market action. You yourself have frequently explained that the market's job is to confound the most people at all times. If your 90% number were correct, we would already be in freefall.

But this blog article and the comments on it and many others I have written or read recently, show the overwhelming bearishness / nervousness of investors. For this reason alone, the market goes higher. There really are not a lot of "patsy" investors to get caught long, maybe with margin, when the market sells off. This is why all the selloffs are quickly reversed. There will be no return below 850 short of some global cataclysm.

All the same, I am nervous like other investors, and have taken some off the table the past few weeks. I was 110% invested in March (using margin and options). I am down to 90% now and will head lower as the market heads higher. There is a natural lid on the market, which is the level pre-Lehman of 1280 on the SP500 (pre financial panic). Like you, I am using SDS sold put options to develop my short position as a hedge. But I don't expect the market to get to 950 let alone 900, for the reasons detailed above. And those waiting for another crash below 650 will wait the rest of their lives, I am afraid, and if they are positioned short, will lose a lot of wealth in the process.

This is not 1930-32. That was the 2001-03 decline (check out the NASDAQ which sold down 80% and still is only 45% of the peak in 2000). As in 1933-36, the Fed engineered a recovery in 2003-07, aided by the beginning of the Iraq war. Now we are in the 1938 recovery phase post the 1936-37 decline. But there is no good historical map from here because WW2 cut off the recovery in the market and we will never know what would have happened sans a world war.

I do not buy this inflation talk either. There just is no evidence of it. Many people here have pointed out the fact that it is impossible to have inflation when there is no demand and massively excess supply and production capacity. The Feds can print till the cows come home and with low velocity due to no demand, it won't matter. The dollars just pile up in the banks, making them more secure / stable, but certainly not igniting inflation ala the 1970s (when we still had a strong manufacturing sector amidst competition from Japan and Germany).




On Aug 21 01:04 PM [e-mail] wrote:

> Adam, "Why do equity markets disagree with the data?" Because, as
> with all else, form follows function. The function of markets is
> to separate outsiders from their money for the enrichment of insiders.
>
>
> That being, wave form and technical analysts have reasonable confidence
> that the markets are simply tracing out their logical patterns with
> the mood swing. Averages have retraced in time and distance with
> Fibonacci ratios. This primary wave is near the trend's end and will
> reverse with bearish ferocity.
>
> Sentiment has grown to near 90% bullish and I'm claustraphobic.
>
> The herd has never, ever anticipated trend changes, but rather piles
> in near tops and refuses to buy when a real bottom has been reached.
>
>
> Once again the market is dominated by the prerational-brain-stem
> instinct to herd. Once again, the shepherds (wolves) inside the pasture
> paddocks shear and eat the lambs and sheep who enter in.

Aug 24 01:28 AM