Apr

17

I'll not make a prediction if this latest rally in stocks is sustainable or not. I don't know. But it is self-fulfilling. Rising stock prices improve consumer confidence, and more importantly send a signal to CEOs and other executives that maybe there is a light at the end of the tunnel, and maybe that light is not another oncoming train.

CEOs, who despite the appearances, are as human as everyone else, may decide to postpone or at least reduce the speed of job cuts as they start taking cues from the stock market.

Thus this stock market rally (if not followed by a sharp decline) may actually help the economy, at least in the short run.

Nigel Davies replies:

Interesting take on things. Optimism is usually associated with the likelihood of a fall, the logic being that 'everyone has already bought'. But maybe there's a difference between new optimism and old optimism.


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5 Comments so far

  1. Shawn Surdyk on April 17, 2009 12:44 pm

    This sounds like S0r0s' theory of reflexivity in action

  2. Rocky Humbert on April 17, 2009 1:11 pm

    Vitaliy’s correct observation is echoed by Keynes in his General Theory:

    Keynes wrote:
    “Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

    “… human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist … it is our innate urge to activity that makes the wheel go around …”

    To the extent that rising stock prices = more optimism, it is entirely rational to foresee the potential of a positive feedback loop.

    Optimism and animal spirits notwithstanding, there are also quite a few serious (and frivolous) coincident indicators to suggest that some important changes are afoot:

    1) Industrial metal prices are rising. Most importantly, the SPOT price of tin and lead traded at a premium to forward prices (backwardation) yesterday. This suggests inventory exhaustion and commercial end-user demand.

    2) The 2-year, 5-year and 10-year swap spreads are back to levels below the original Bear Stearns implosion. Yesterday, JP Morgan sold a $3 Billion 10-year bond issue without any FDIC assistance, and Goldman Sachs was able to place $5 billion in new equity. These were the first important new issues (without Uncle Sam’s thumbprint) since the Fannie/Freddie nationalization.

    3) For the first time in recent memory, an IPO came yesterday and went to a substantial premium (RST).

    4) My favorite psychological indicator is the chart of google search hits on Nouriel Roubini. Chart-watchers will note that it’s making lower highs and lower lows — meaning that Roubini is a short. ;)

    See: http://www.google.com/trends?q=nouriel+roubini

  3. Gary Rogan on April 17, 2009 5:48 pm

    This is all an illusion supported by mark-to-market “these are my assets an I’ll value them the way I want to”, massive AIG unwinds, cumulative effects of of under-40 oil, foreclosure moratoria, and debt monetization. Yes, there is some typical inventory restocking-driven bottom-of-the-recession action which would normally continue, but the debt levels, public and private are too high, there are many more foreclosure shoes yet to drop, and the Chinese are getting REALLY hesitant about feeding the dollar recycling monster. Market animal spirits can only work if they result, quickly enough, in sustained consumption that will feed more production and more lending, and thus employment. Rising delinquencies due to the end of foreclosure moratoria and unemployment-based (as opposed to the liar loan based) foreclosures couple with no Chinese dollar recycling coupled with slowly rising oil coupled with higher rates as the Fed has to step up it’s Treasury purchases will kill the mini recovery. Fundamentally, debt doesn’t disappear by itself. Even the highly suspect Keynes didn’t believe in ever increasing pump priming, he wanted some savings in good times, and if you are perpetually priming the pump on borrowed time and money sooner or later you run out of ammunition. When the inventories are restocked who will keep supplying aggregate demand when the housing supply will take years to work out even if all building activity stops and every months bring hundreds K more through foreclosures? The slightly increased savings rate and the equity rise-based wealth effect will be overwhelmed by the housing based negative wealth effect.

  4. Andrew McCauley on April 17, 2009 9:57 pm

    The difference between new optimism & old optimism could be quantified by starting level & follow through response.

    The follow through response post a strong rally from say -30% below an all time high (new optimism) is somewhat different to a strong rally from an all time high (old optimism).

    For example, in Australia as at 27th March 2009, the All Ordinaries Index had gained just over 15% in 15 trading days. A rally of this magnitude in such a limited time frame has only occurred 40 times (with overlap) since 1958.

    Adjusting for overlap with no regard to starting level provides an ambiguous outcome post this condition.

    However, adding the condition that the 15 day rally of 15% plus occurred from a starting level that was at least -30% from the all time high (new optimism) reduces the sample size to 4 observations with adjustment for overlap. March 2009 marked the 5th occurrence.

    On all occasions post this condition the All Ordinaries Index was significantly higher 3 months (65 trading days) later with an additional average gain of just over 12%.

    Interestingly, the average closing low over the 3 month period was approximately -4%. These shallow pullbacks (in context) could be a function of those who missed the initial burst not wanting to repeat the episode.

    Reducing the conditional starting level to -20% below the all time high also yields a significant 3 month return of just over 10%.

    Perhaps a meaningful pullback does not occur until the general agreement amongst market participants is that rally is more significant than just another Bear Market rally.

    New & old optimism as a predictive tool is an area that probably warrants further attention.

  5. Paolo Pezzutti on April 19, 2009 9:09 am

    I believe it is true that markets contribute to shape fundamentals. We do not know however if the current rally will be able to influence the economy. As far as this rally is concerned I tend to believe that it is not in the position to play this role. I see it more as a mean reversion reaction after an extreme move to the downside. It is too early to say that it is anticipating a stabilization or recovery of the economy.

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