November 25, 2002
Innocence Lost
If the average American investor buys into this rally they will have only themselves to blame.
A deluge of economic reports are on tap this week, including 3Q02 GDP, October personal income/spending, existing housing sales, durable orders, and the conference board’s help wanted index. However, with all of these reports being of the ‘rear view’ variety (only the confidence reports and Chicago PMI are for November), the markets may find little new information to trade on. The Fed’s Beige book is due out on Wednesday.
Fed McTeer joins the long list of Fed members that have chanted the benefits of an easy Fed policy. During his speech McTeer added, “Never underestimate the power of the consumer to spend money…”
While McTeer is obviously right – the consumer has surprisingly continued to spend during the last ‘three to four’ years – he doesn’t, along with any Fed member for that matter, seem concerned that overestimating the power of the consumer will ultimately mark a huge misstep in monetary policy one day. Point being, when the consumer no longer responds to Fed rate cuts the Fed may no longer have a response to exactly why the economy must improve. To repeat what has been repeated often: the Fed has nearly played all their cards.
The Rally That No One ‘Invested’ In
People are quick to state that investor’s have learned from the mistakes they made during the 1990s. However, and in light of the recent run up in the markets, if investor’s gambled on stocks yesterday, should it not be accepted that they are gambling on an economic recovery (stocks) today?
“We're all coming back down to earth after the bubble of the late 1990s. It took 2 1/2 years of painful declines, but by early October, stock prices had fallen to levels that anticipated a double-dip recession. Since then, corporate profits have started to perk up, and the recent Fed rate cut should help keep the recovery on track.” Yardeni
How Mr. Yardeni assumes that stock prices were pricing in a ‘double dip recession’ in October is unknown. To be sure, during the so called ‘2 ½ years of painful declines’ the stock markets never once reached below average valuation levels (as they previously have done during every severe bear market before.) As for Yardeni’s ‘perk up’ statement, this is somewhat bewildering, as 3Q02 S&P 500 earnings are up 6.9% and revenues are up 4.3% compared to exceptionally brutal 3Q01 numbers. Lastly, ‘the Fed cut should keep the recovery on track’ – this seems to be, along with Bush’s expected tax cuts, all anyone can talk about to form a bullish bias.
Yes, Wall Street is using the exact same criteria they used during the great bull market to convince ‘investors’ that things are great. In other words, Wall Street is justifying seemingly irrational movements in stock prices by plucking away at optimistic possibilities for the future. By incessantly focusing on the future the stock markets remain in a perpetual state of recovery, always ignoring weakness today (remember, we were told that even the dips in July and Oct were caused by of corporate shenanigans, terrorism, and the threat of war, not necessarily because the economic outlook was miserable).
Granted, Wall Street’s bias is not as ridiculous as yesterday – no one on The Street is upgrading stocks to stratosphere price levels based upon revenue gains. Nevertheless, it is worth remembering that he 1990s were coined a ‘mania’ because people chased stock prices, because earnings were no longer relevant, and because people believed in a ‘new’, unquantifiable economy. Flash forward to today: despite what you may have heard the U.S. economy is weakening, earnings are up marginally compared to terrifically bad 3Q01 numbers, and no one can quantify how positive the impact of the Fed’s latest cut, if any, will be.
Need more proof that the markets are in a mania right now? If so, Business Week’s Amey Stone, who picked up the Yardeni quotes, has got it covered:
‘A few more weeks of gains and all those dour CEOs might start to feel better and begin investing again rather than trimming budgets. With expectations for economic growth so low, a little optimism, starting with investors and spreading to Corporate America, could go a long way.”
Can, as Ms. Stone suggests, everyone ignore the current cold realities – that stocks are trading at rich valuations, the U.S. economy is weak, and corporate America has 25% unused capacity – and continue to buy stocks? Will companies construct their capital investment plans by looking at what level the Dow is at?
Who knows, maybe optimism can go a long way, just like it did during the late 1990s. Nevertheless, and in light of what happened to 1990s optimism, is buying stocks based upon Yardeni’s or Stone’s comments an investment or a gamble?
Conclusion
One of the biggest lies circulating right now is that ‘investors’ are responsible for the latest surge in stock prices.
“So why the run-up in stocks? Part of the explanation may be simply that investors have finally adjusted to a slow-growth economy.” Stone
In the coming weeks it will undoubtedly be confirmed, based upon mutual fund inflows, money market stats, etc. that retail investors played a small role in sending prices higher over the last 7 weeks. Rather, what has happened is four things:
1) Shorts have covered their enormous positions at a faster rate than at any other period during the bear market.
2) Fund managers are trying to boost returns by buying any stock that moves because they face no reprisal if they fail (Fleck’s insights).
3) There have been sizable asset shifts from bonds to stocks (the most notable being Buffett’s dumping of zero’s before the stock market rally began). Some of this money has landed in ‘the markets’ (not Buffett’s).
4) Some suckers, who the Yardeni’s and Stone’s think learned from their mistakes, are moving (more) money into stocks.
Other than number 4, or the small investors who actually try to buy and hold, not much of the money that has found its way into stocks during the latest rally is fixated on a sustainable U.S. recovery. Rather, some money (Wall Street) is chasing momentum and will dump as soon as the tide stops rising, some money is nudging the shorts out of the game, and some money is fearful that bond yields are too low (stocks by default).
That said, if ‘sidelined’ investor money does enter into the equation, which I highly doubt it will, it won’t be a repeat of the 1990s. Rather, this time when the momentum stops and prices crash no investor can plead ignorance; no one can say that Wall Street took their portfolio for a death ride. Why? Because Wall Street is doing the same things they did yesterday! In sum, and after the sympathetic downfall of millions of naive ‘new economy’ investors during the great bear market, it is up to each individual to know not to climb aboard today.
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