Has the Market Decoupled from Economic Reality?

While the bulls flex their muscles day after day, it is daunting for those who believe that the economy is not on sound footing and that the latest earning season is not about to suddenly provide a cornucopia of better than expected earnings - especially since expectations have been ratcheting up so much recently.

More and more, this is a technically driven market, decoupled from such mundane things as P/E or the economy or any type of anchor we may think is rational to attach to it. We just ricocheted off the S&P 500 index’s 50 day moving average. If you recall back in June and July it was the 200 day moving average which buttressed the index before turning up itself.

But arguing with the market is about as useful as standing in front of a runaway train and doing a PowerPoint on why it should stop in its tracks. Remember that bears have always had the most lucid and convincing arguments.

I’ve been guilty of comparing this spring rally to the 2003 cyclical bull market. If you’ll indulge me once more, here is yet another point of similarity.

The percentage of S&P 500 components which trade above their 50 day moving average fell through the floor to hit the basement in the summer of 2002. Those were dark days indeed. Then even as the S&P 500 index went lower, this metric did not - suggesting that less and less individual stocks were participating in the continuing bear market:

The first sign that things had changed was the almost unanimous involvement of the components in the ensuing rally. In June 2003, out of the 500 stocks in the index, 471 of them closed higher than their intermediate moving average. Then it started to show a remarkable resilience as each subsequent low in this metric was higher than the previous one.

Here is the recent chart of the percentage of stocks above their 50 day moving average, showing a remarkably similar script:

A caveat is that we are starting to see some speculative fever getting stoked in the options pit. But even this is not extreme enough (yet). The market resilience continues with few signs of abating.

Comments

[rich168:]

This is cheap money flowing into the markets.

With interest rate so low. Traders are taking advantage.
no margin calls as of the moment.

Bubble in the making?
Could be....

Oct 08 01:37 PM

[Jason Tillberg:]

Bubble in the making.. more like bubble made. AMZN for example.

Oct 08 02:11 PM

[User 353732:]

There are 4 great decouplings occurring in parallel in the USA in 2009:
1. The decoupling of the productive economy from financial/commodity markets......driven by the tremendous mal-allocation of liquidity and unjust allocation of risks
2. The decoupling of debt from the value of assets and of debt service from income needed to support the debt.....fiat money will do this
3. The decoupling of consumption from work..... caused by entitlements and desire for instant gratification
4. The decoupling of the Bosses from the Constitution..... an untrammeled lust for power, wealth and fame at the expense of everyone and everything else will do this

The decoupling of financial markets from the real economy is the most visible but least toxic of the 4 decouplings.

Oct 08 02:38 PM

[Gary A:]

The higher it goes, the harder it falls. Even Cramer is admitting the high unemployment and the Nucor CEO is very, very alarmed. DiMicco says that jobs should be first priority and the second priority and the third priority.

Mr Geithner-Nero, and Mr Summers-Nero, your damn country is burning.

Oct 08 06:34 PM

[ryanclarke:]

If you look at the past ten years earning's history (google standard poor's earnings to get a link to the spreadsheet) you would discover banks have a tendency to wait until Q4 to take losses on their losses for the quarters of Q1, Q2, Q3, Q4. I have no doubt banks have yet to write off all the housing and commercial and business loans; otherwise, I would be able to walk into any bank and get a loan for a house without question, or even an increase on my credit card credit limit. But such is not the case. I'm 90% sure I'm correct, but I could be wrong and you could be right. But if you are right then I can rest assured the value of the U.S. currency is not as valuable as everyone assumed it to be, that is, with an improvement in employment and gasoline consumption ... pump prices will go through the roof ... and then the market will tank.

Oct 08 06:50 PM

[bartpr:]

the eventual correction of the 2003 leg was 17%, and the economy was much better then. when the mut funds run out of money(gas)
the correction will take place.

Oct 08 08:30 PM

[TonyCinTX:]

The answer is simple; the government has proven by its actions that they have decided the Fortune 100 companies must not fail. The decoupling mentioned by User 353732 above is decoupling risk from performance. As has been said before, the Fortune 100 has pretty successfully privatized profit while making all risks a public responsibility, with losses now borne by taxpayers in the form of government bailouts, stimulus, zero-interest loans, and on and on.

The value of the DOW and S&P 500 companies has risen because risk has been abated, and in some cases eliminated. Smart, big-money investors discount prices for business risk, but when risk vanishes the discount is zero and the price rises.

This is why stock prices jump (in either direction) after a contract is signed or declined, or the FDA approves a drug or decides against it, or a lawsuit is settled in favor of or against a litigant: Until the final signature, bets exist on both sides, after it, all bets are settled up.

Well, my fellow citizens, we have collectively spent about a trillion dollars this year defining a whole brand new class of corporation in this country:

Too Big To Fail.

Oct 09 09:21 AM

[David Van K...:]

"Remember that bears have always had the most lucid and convincing arguments."
-----
I keep reading this lately. I'm not so sure. The bears certainly tend to be the shrillest, most sarcastic, and most self-assured, but that does not make their arguments "lucid" or "convincing."

I suspect that what makes bearish arguments seem convincing at the moment is that they are usually tied to current or just-past reality...earnings are down, P/E is up, therefore it's crazy that the stock market isn't down, so a crash is imminent.

While sometimes that reasoning holds sway, in the actual market, people are attempting to see where things are going, not where they've just been. That's why the market can go up, as it has for six+ months, in the face of fundamental data that is down. What's missing from many bearish arguments is the likely future direction of those fundamentals.

It's not just bears. When the market turns downward (as it will at some point), it will be the bulls who seem to have the most convincing arguments, because what they are saying will appear to be supported by current and immediate-past data. Perhaps the bulls will become shrill about it ("pounding the table," "back up the truck"). And they will be just as wrong as the bears have been for the last six+ months.

Don't confuse shrillness and in-your-face insistence with lucidity and convincing interpretation of the facts.

Oct 09 10:05 AM

[AllStreets:]

The whole rally has been a short squeeze. After investors sold out in 2007-2008 the market makers were loaded with stock and lots of investors were short. Now as the averages have hovered near rally highs for three months and have made marginal new highs with the % of stocks above their 50-day moving average hovering in the 80-90% range, the typical maximum rally highs. But note well that as the indexes keep making marginal new highs there is now a bearish divergence as the % of stocks over their 50-day averages has dropped into the 70%'s! The bearish divergence that has developed in Augst-October appears to be a mirror image of the bullish divergence in March '09.

The flagging momentum is most likely a harbinger of a correction or bear market of some type. Wherever and whenever it stops most likely a bullish divergence in the bullish % will likely tell us again. At that point the majority will again be bearish, will have many reasons why the economic recovery isn't going to happen (yield curve notwithstanding), and will agree that everybody should have seen it coming since earnings can't increase in such a bad economy, and the banks hadn't yet recognized their losses yet. I expect that phase of the market will be accompanied by widespread recognition of soaring bankruptcies and bank failures as the many unemployed run out of benefits and file for BK and lose homes in foreclosure.

Oct 10 09:04 AM

[AllStreets:]

Speaking of moving averages, the SPX is trading below its 50 week and 200 week moving averages, both of which are now declining. A 62% Fibonacci retrace of the 900 point decline from 2007 peak to March, 2009 trough is about 558 points, so the retrace point is 1233, at which point the ndex will be into resistance formed in 2005-2008, also the breakdown point of December, 2008. If the index went to 1233 in the very near term it would be right between the declining 200 week and 50-week moving averages.

I should also note the trading range between 675 and 975 of 300 points between September, 2008 and July, 2009. The breakout from that range projects the price to 1275 and the market should trade above the range for 10 months. If the index went to 1233 quickly, most likely there would be many bearish technical divergences and too many bulls. If the market spends considerable time trading near current levels before moving up, that would set the stage for a more extended bull market as some kind of economic recovery becomes reality.

I should also note that the market has spent about 5 years trading above 1250 (1999-2001, plus 2005 to 2007), and, so far, in that time span somewhat over 4 years below 1250. A principle that often works is that prices will spend at least as much time below a price range as the most recent time span above that range before it can break out above the boundary of the two ranges. That means about another 6 months to a year below 1250 before it can go higher. I supect we'll see a move to 1230 within the six months, probably after a short correction or trading range, and then a more significant corrective trading range of 1000 to 1250 in 2010 awaiting more confirming positive economic performance (10% bull market correction from 1230 = 1107, or a mini bear of 19% from 1230 back to 1000). The possibility exists that the market will correct from near here to the 950 breakout level by the end of the year, to test the yearly low of 2009 in early 2010, but that would be counter to normal seasonal patters of a rally from October lows through the end of the year. Disappointing earnings reports could support such an abnormal seasonal pattern. If that happened first, it would actually be a much healthier pattern for 2010 and beyond since the base would be strengthened before the move up.

Oct 10 10:11 AM

[thiazole:]

I was just going to post something similar. Conspiracy theories and misunderstandings of index PE ratios have never seemed like lucid arguments to me.


On Oct 09 10:05 AM David Van Knapp wrote:

> "Remember that bears have always had the most lucid and convincing
> arguments."
> -----
> I keep reading this lately. I'm not so sure. The bears certainly
> tend to be the shrillest, most sarcastic, and most self-assured,
> but that does not make their arguments "lucid" or "convincing."
>
>
> I suspect that what makes bearish arguments seem convincing at the
> moment is that they are usually tied to current or just-past reality...earnings
> are down, P/E is up, therefore it's crazy that the stock market isn't
> down, so a crash is imminent.
>
> While sometimes that reasoning holds sway, in the actual market,
> people are attempting to see where things are going, not where they've
> just been. That's why the market can go up, as it has for six+ months,
> in the face of fundamental data that is down. What's missing from
> many bearish arguments is the likely future direction of those fundamentals.
>
>
> It's not just bears. When the market turns downward (as it will at
> some point), it will be the bulls who seem to have the most convincing
> arguments, because what they are saying will appear to be supported
> by current and immediate-past data. Perhaps the bulls will become
> shrill about it ("pounding the table," "back up the truck"). And
> they will be just as wrong as the bears have been for the last six+
> months.
>
> Don't confuse shrillness and in-your-face insistence with lucidity
> and convincing interpretation of the facts.

Oct 10 11:35 AM