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Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend and step off before it is discredited. -- George Soros

Think about that statement for a minute. For everyone who is in the so-called bear camp, and thinks the current "recovery" belongs in quotation marks, this is an exceptionally meaningful quote.

Of course, everyone who has been bearish on the markets since 2009 has largely lost money, and been quite aggravated in the process. Had trillions in stimulus and quantitative easing not been injected into the economy (the big banks for the latter), our economy would have simply restructured and our markets would have bottomed at values far lower than they did. Bearish market participants have been investing with the philosophy that this will still happen.

Many bearish market participants have recognized the dynamic that there are long-term structural deficit and various economic issues, and that the economy is simply being goosed by trillions in cash and dangerously low interest rates. In other words, the bears scream that "the economy is unsustainable;" If and when rates rise, servicing trillions in debt is going to require even more debt issuance, leading to ever higher rates and a crowding out of the private sector. At this point, people draw different conclusions as to what happens next.

Others note that the euro is going to break apart, and it too is only being held together by programs like LTRO and other central bank intervention.

Regardless, many have come to the conclusion that our equity markets are fundamentally overvalued and do not discount the structural issues we face. The best argument I've heard for overvaluation is that corporate profit margins will contract rapidly when the U.S. government needs to start cutting its budget; we may be approaching that day with the creeping "fiscal cliff" at the end of the year.

With lower margins and lower aggregate demand (less government spending), both sales and bottom lines will contract. The earnings of companies in the S&P 500 (SPY) will decline, and stock prices will follow them downwards. With analysts currently expecting at least $100 in earnings for 2012, and $113 in 2013, the market is definitely not discounting any type of drop in aggregate demand or corporate profit margins.

Utilizing Mr. Soros' Advice

The important factor, however, is what this means for traders and investors trying to make money. After all, making money is a lot more important than being right, isn't it?

What we're seeing today isn't anything new at all. While the Fed's intervention this time around may be unprecedented, it's fair to say that FDR's government programs following the Great Depression were unmatched as well. How about interest rates of 1% following 9/11 to stimulate demand and get everyone shopping again? It contributed to a housing bubble, widened the wealth gap, and harmed our political system.

During those periods, the bears complained about the same things: the unsustainability of low rates, government intervention, and huge deficits.

However, markets boomed for most of the 1930s, set record highs right before the recession, and have doubled since all these actions have started taking place. There have been three camps of market participants during these times:

  1. "Everything is great, the economy has clearly restructured and the bears are just whining that they missed out."
  2. "We're doomed. Markets are going to zero, another Great Depression is near, and unconstitutional government intervention has made things far worse."
  3. "I don't care. I'm either going to keep buying my dividend stocks, buy assets that do well when governments print money, or go long the broader market until the government either gives up or can't prop it up any longer."

The last of these three, of course, is George Soros. Over the past several years, Soros has made money owning gold, equities, bonds, and currencies. He knows Europe really is doomed. The EU is going to have to at some point write down trillions in private and public sector debt, and an actual, painful restructuring will finally take place. He knows gold's price moves in cycles, that it's not a compounding investment, and that it will plummet once the macro landscape shifts to a more positive one. He also knows that investors buy gold at times like these.

Jim Rogers hates the US dollar. He is certain that the U.S. government has spent its way into a hole so deep it'll have to default either by printing or not paying its creditors. Jim Rogers also knows that the market perceives the dollar as a safe haven right now, so he owns millions in US dollar currency futures for the time being. My bet is that he'll sell long before the dollar loses its safe haven status.

Conclusion

One of the best things you can do as an investor or trader is to have a sober, analytical, pragmatic view of the economy. Always invert your thinking, and try to understand all possible viewpoints. The obvious macroeconomic dynamics are obvious because they're true. What's not so obvious is the underpinnings of market perceptions. The beauty of markets, though, is that you don't have to understand the reasons for why investors buy certain assets or equities to be profitable.

Jim Rogers can't understand why investors have been flocking to the USD recently instead of gold. Instead of whining about "the manipulated price of gold", however, he's been hedging his positions in gold and buying the dollar to take advantage of its rising value.

George Soros' quote sums up what the best investors and traders know about macroeconomic and market dynamics: most of it is noise, all that matters is the trends and a few indicators and analytical skills to tell when the train is slowing down.

Next time you think you've got the economy figured out, ask yourself if your long-term viewpoint has matched up with the market trend. If not, then you're not making money, and not taking advantage of everything you know.

Source: The Best Investment Advice George Soros Ever Gave