Market Sentiment and Reality

by: Jeff Miller

We do not indulge in the very short-term market calls. It is a popular thing to do, and someone has always made a spectacular prediction. Our problem with these methods is that they are not testable. Someone is always right, but how should one evaluate the overall record?

Friday's Trading

On Friday we saw a steep decline in the market averages that was the virtual flip-side of the pre-weekend trading seven days ago. What was the difference? The hot-money traders learn quickly. A single data point is enough!

Charlie Gasparino's prediction last week of a "bailout" for the bond insurers did not pan out. End of story. Actually, the Gasparino coverage was quite strong. He revealed some of the actual discussions, showing that there was a dialog among the insurance commissioners, the potential investors, and the ratings agencies.

To anyone with some understanding of how agreements are formed, this should be good news. The rating agencies are not rolling over and accepting anything. The investors are listening and crafting a package. There will be time allowed to do it right.

Meanwhile, investors are acting like spoiled children. We want a solution, and we want it now! There is little understanding that problems which develop over years might take a few weeks to solve.

The Bearish Victory

The disparity between expectations and data continues. Those with a bearish bent argue that there is already a recession, it will be terrible, it is not priced into the market, earnings estimates must move much lower, and there will be a general calamity on the scale of the 70's stagflation or even the Great Depression. Wow!

When stocks move lower, it seems to prove the point. This is most interesting and worth some thought.

Anyone who claims to provide a market edge, almost by definition, must find occasions when the market is wrong and the analyst has a superior viewpoint. The most bearish economic pundits now get to claim victory -- even if the economy never enters a recession!

It is not necessary to be right on the facts to be right on the market. As the market moves lower, there is a building sentiment that it "must test the January lows." This advice is usually offered in a deep and stern voice. If enough people believe it, it happens. It is seen as proof of the economic forecasts.

We are now a few points away from those lows in the S&P 500 and even closer in the Nasdaq.

Data, Anyone?

Meanwhile, there is a different picture available to those willing to look at data.

  • Yesterday's ISM number was widely publicized as showing contraction in manufacturing. The actual data are consistent with GDP growth of 2.0 - 2.5%. This is much better than most think.
  • All of the consumer data shows record spending. David Malpass writes "Many U.S. indicators are at new all-time records, including the February 29th data on consumption in real terms ($8.351 trillion annual rate in January) and both income and consumption in nominal terms ($11.93T and $10.02T respectively).
  • Earnings results outside of financials have been excellent. Financial earnings have been hit by write-downs enforced by marking to market in extreme conditions. The jury is out about next year, but many see the artificial markdowns as contributing a bounce.

Markets can, should, and will look ahead...

Media types and bloggers have a fixation with scare tactics like "stagflation." The cooler heads, like Bob McTeer, try to make careful and reasonable comparisons. Take a look at his latest thoughts.

Meanwhile, the markets have underestimated the impact of Fed rate cuts and the stimulus package. These will start to show up very soon -- perhaps in a month or so.

A Final Observation

There are other policy actions in the works. It is popular to point at the list of potential housing foreclosures. In fact, it is open season for those working to avoid disaster.

So many are so busy at the job of criticizing government officials. In this environment it is easy for the investor to forget a key point.

Those who chose to work in government did so because they wanted power rather than salary. When we tally up the results, whom do you think will be proven correct: The critics, or those who actually have the power?

Our bet is with the Fed and the Treasury.