Jul

24

There is much pessimism on the site about the stock market. One thing I always like to ask is suppose it were true that the economy is really going to be weaker than people expect. Like we'll have 1 or 2% growth rather than 2 or 3. Why should this affect stock prices? What is the evidence that stocks do worse during periods of below average growth? Why should it matter? How does the rate of return on capital of businesses compare to the 30 year rate as stocks are valued based on discounted value of expected future earnings adjusted for risk, with the growth rate of earnings being determined by the rate of return on capital less the pay out on dividends rate. Is it better to buy stocks when people are pessimistic or optimistic?

All these things must be tested. I'm not saying that I'm bullish or bearish on stocks or that one should be. I'm just questioning the glue and the weakness type of stuff. Assuming it was true, which I doubt, why should that be bullish or bearish? Testing is required.

Steve Ellison writes: 

A regression of the 1-year S&P 500 return from 1981 to 2010 against the US unemployment rate reported the previous December shows a 16% positive correlation, with the regression line for the next year's S&P 500 net change being -1.9% + (1.9 * unemployment rate).

t=0.86, p=0.40

Leo Jia writes: 

I often ask myself similar questions but can not answer them. Perhaps one has to answer this question first: what percentage of the people in the market are rational? Or rather, what percentage of the money in the market is rational? Though I don't have an answer, I tend to believe that there is more irrational money than rational money in general. The clear problem is that the degree varies all the time.

J.T Holley writes: 

With the std dev of 18% and annual rate of 8-9%, I'll order a double helpin' of "drift" with a side of "thank you".

If that meal doesn't fill you up then you must question where you get your meals and disregard the gratuity the next time you sup.

Tim Melvin writes: 

Drift only exists if you have a 100 year time frame in my opinion. See 1970s and 2000 to present. Much of investing success last fifty years for most investors is result of membership in lucky sperm club.

Craig Mee writes: 

Doesn't one new variable in a mix during the testing period influence the outcome– QE, no QE, etc etc…(sure, there's been other ways of doing it). But how to judge what has the over riding influence on the outcome? This could vary under certain conditions. How much of the US equity recent rise is in default of Europe, just like EURGBP taking the heat…and how much of the current price is underpinning based on QE to come?

What has recent price action illustrated, if anything at all…

How should weaker growth effect share prices? I would argue that this would just be a further nail in the coffin, when all the ducks are lining up, but how can we say it's got more weight currently than some other significant half ? It's tough. Are the number of running variables any different than twenty years ago? Maybe not. Are market conditions, HFT, leverage, number of participants in the market any different? Certainly. Has this influenced price action? Maybe Richard Dennis may have some views here.

When does the variation in conditions influence the ability to test? I suppose this might be the question.


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2 Comments so far

  1. Pacific SW on July 24, 2012 7:40 am

    vic, it’s not about 1% growth. it’s about negative real yields all the way up to 20 years. it’s about 10,000 baby boomers retiring every day. the return on capital of businesses has been dependent on gubernment printing, not on wealth creation. the two are tied at the hip, it seems.

    to use a parable, this could be how money goes to die. with a whimper, not with a bang. first japan, then europe, then this. it does not compute. the bernank is buying everything in sight. He ran out of gov. debt, but will continue to MBS, REITS, stocks, vacation houses, boats etc. until the fed balance sheet will own the whole economy. then he can raise the red flag with the hammer and the sickle.

    that higgs boson better yield something more than an ipad app, to get us out of this.

  2. Craig on July 24, 2012 8:50 pm

    Pacific SW is right about the same water running under the bridge with the US having a 10yr lag on Japan. Business cycles matter though even if tough to time. Stocks peak 7 months before a recession usually and normally bottom 3 months in. An investor would know to be careful when the lagging index is the strongest. It’s been outpacing the economy since April 2011 and the economy has been totally inverted (lagging, coincident, leading) since September 2011. Previously, the economy inverted in August 2005 and July 2000. Inflation matters, so the leading inflation index becoming the strongest in 1999 and the second half of 2005 wasn’t something you want to see late cycle. If the economy corrects, it’ll be time to look at stocks when the lagging index turns negative. 2001 looked interesting in April I think it was but seasonality was rolling over, so you had to wait to get though the negative seasonality to see how we shaped up. We decided to follow the global recession path and the rest was history until we reached the similar low point as the 1973-75 recession. Economics work but most people look at the numbers instead of relationships. 1986 saw the leading inflation index soar to become the strongest index. Even CPI did a late cycle ramp up. The Japan Long Leading Index was strong, so you didn’t have to be particularly bearish on stocks and the economy to see yen was the place to be. If you think the positives of a loose Fed and the weak leading inflation numbers are bullish for stocks, it still doesn’t mean you want to invest with an economic inversion setup. Doing nothing is sometimes the best thing you can do. Maybe we get another runup in the grains between the Aug3 employment report and Aug10 crop report.

    On a different note, wonder why we have to worry about the downside whenever nyc barometric pressure falls below 30?

    http://www.wunderground.com/history/airport/KNYC/2012/7/1/MonthlyHistory.html?req_city=NA&req_state=NA&req_statename=NA

    Also, what’s with these 50c drops in silver at 6pm that only last 1min? Today was only 10c but it’s still not right.

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