What's Behind the Market's Move?
The market may speak to us, but many times it is hard to hear - many times it speaks to us in a language that is hard to decipher.
A worried man with worried mind,
No one in front of me and no one behind
There's a woman on my lap and she's drinking champagne
Got white skin, got assassin's eyes
I'm looking up into the sapphire-tinted skies
I'm well dressed, waiting on the last train.
Standing on the gallows with my head in a noose
Any minute now I'm expecting all hell to break loose.
People are crazy and times are strange
I'm locked in tight, I'm out of range
I used to care, but things have changed.
-Bob Dylan (Things Have Changed)
To trace something unknown back to something known is alleviating, soothing, gratifying, and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… the cause-creating drive is thus conditioned and excited by the feeling of fear.
Walking down the beach one day, shortly after moving to Malibu in 1999, I was introduced to a legend, a trading legend.
Not one to mince words, after a few minutes I blurted out, "What do you think is the secret to your trading success? If someone put a gun to your head, what would you say is the one most important thing to understand about the market?"
His answer: "One day a few years ago I was walking down this very same stretch of beach when I stubbed my toe on something. Kneeling down to uncover the object, and brushing away the sand, a genie appeared. Yeah, a genie popped out of a magic lantern, and said, 'You have one wish, your wish is my command.' I thought for a moment – well, I have money, a great family… There is one thing I responded, 'I love Hawaii, but I'm afraid of flying. Could you build a bridge from Malibu to Hawaii?' 'Do you have any idea what kind of engineering it would take for a project of that magnitude?' the genie exclaimed. 'Isn't there anything else, anything at all?' 'Well, there is one thing. I always wanted to know how the market works.' 'Two lanes or four?' replied the genie."
So much for the Malibu magic lantern.
If there is a journey that will make everyone believe, surely the market is on that journey. It is an extraordinary path, a path surrounded by a forest that defies the laws of economic gravity – a forest dense with stocks that grow to the sky.
What's behind the market's move? What is the explanation for the recent, unprecedented parade of up days, up months and up years – the second longest conga line of advances without a 10% correction?
Is there an explanation? It's not as if the market hasn't had plenty of things to worry about and ample excuses to sell off. High energy prices, a sick housing market, Iraq, Iran, huge government deficits, etc., etc., etc.
The fact is, nobody knows exactly what is going on, or why. The market may speak to us, but it never says anything unequivocally. The market may speak to us, but many times it is hard to hear – many times it speaks to us in a language that is hard to decipher.
This has been a particularly, remarkably enigmatic period. A period more short of sense, and long on exuberance than most. It's a new, New Era.
For example, on the crash day of February 27, 2007, the advance-decline ratio for the S&P 500 was 99.5 to 1. This is the worst ratio in history. And history is a long time. It is worse than the two October crash days in 1929. Worse than Black Monday in 1987.
After such intense selling, I don't think there were many technicians or students of the market who thought we would be at new highs anytime in a hurry. And yet…
Moreover, as if the advance to new highs so soon wasn't unusual enough, the recent string of advancing days has not been seen since the late 1920s.
Virtually unprecedented is that this four year plus advance was not built on the kind of base normally associated with Bear market lows. At the October 2002 low, the DJIA was overvalued by prior Bear market measures. For example, in the past Bear market lows have been marked by price earnings ratios in the DJIA of 6 to 8, and with dividend yields near 6%. Contrast this with the 2002 lows where the DJIA showed a dividend yield of only 2.2% and a price earnings ratio of over 40!
Additionally, historic Bear market lows have been marked by substantial periods of substantial bearishness. This was not the case at the October 2002 low.
In fact, there has been a plurality of bullish advisors over bearish advisors for one of the longest periods on record.
Yes, this is an extraordinary period. The market acts differently. Things have changed. This is a market that many participants no longer recognize.
Explanations? You want to go to the ideologue prom? For starters, let's try the largest hyper asset inflation on God's green earth, and under the yellow sun. In a nutshell, money growth has been double the needs of the real economy. It's gotta go somewhere. This hyper money is going into art and stocks. It's no longer going into real estate – which curiously may serve to simply inflate the art and stock markets that much more.
Explanations or excuses? Reason or rationale? You and I can come up with a reason for, and an argument for, anything. But the point is - at significant market turns, people will believe whatever they must believe, when they need to believe it. Many explanations are better than one.
At the October 2002 low there were plenty of 'reasons' to believe the trend would continue to mirror the bad news. At market highs there are plenty of 'reasons' to believe that fundamentals will catch up with price.
It is true that the market chews up and spits out all the background news in its omnipotence. It is only wrong twice – at meaningful tops and at meaningful bottoms. That's where things change. That is where the character of the market changes. At tops, it is when the tide turns from buying weakness to selling strength.
On Tuesday, such a potential change in character appears to have played out. For the last seven weeks or so, early strength in the day has followed through into strong closes. On Tuesday strength fizzled. A more than 11 point S&P rally to a new seven year high met with sellers, as the index closed two points in the red. Likewise, a triple digit DJIA rally folded its tent. Although another new record close was recorded in the DJIA, the index gave back the lion's share of Tuesday's gains closing up only 37 points.
Follow through from Tuesday's reversal of fortune from new highs will be worth watching. It will be interesting to see whether profit-taking will continue, or whether, as was the case last Friday morning, Bulls will once again jump in after a few hours of selling to chase 'compelling' values. It will be interesting to see if that same sense of urgency prevails on any new round of profit taking.
If the S&P does follow through to the downside Wednesday, things may have changed – the Bulls may be out of range - at least into options expiration on Friday.
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