Getting Close to a 'Recalibration'?

Many people are cheering the fact that the Dow Jones Industrials Average has reached an apparently signficant milestone -- 10,000 -- and are suggesting that it means good news for Main Street.

Yet even during more "normal" times, the relationship between the stock market and the economy has been rather tenuous, at least in the short run. Think back to the feeding frenzy that was occurring just over two years ago, when clueless traders pushed equity prices to all-time highs as the financial world and the real economy were undoubtedly falling apart.

Generally speaking, share prices can be influenced by any number of factors, not least of which is the mood of traders -- what some refer to as "animal spirits" -- and the amount of cash that is available for speculation -- er, investment. Conditions on Main Street don't always enter into it.

In the end, of course, if the fundamental reality fails to match or catch up with the exuberance of the trading crowd, then that sets the stage for a "recalibration"of some sort, which can be swift and violent if the differential has reached unusual extremes.

Is that where we are now? If you read the following sampling of commentaries discussing what I would describe as the Wall Street-Main Street disconnect, I think you'll find that the answer jumps right out at you:

"Why The 10,000 Point Dow Doesn’t Matter" (Bill George's Blog)

The Dow is at 10,000.  Reporters glow.  Retirees relax.  Investors sigh: “Whew, we’ve made it.”

They’re wrong.  This purported milestone isn’t a victory.  It’s nonsense.

The market is the wrong place to look when measuring the health of our economy.  The collective wisdom of mutual fund analysts was wrong in 1999, wrong in 2006, and it’s wrong right now.

The best investor in the United States basically ignores Wall Street.  Warren Buffett has billions he could trade in and out of stocks.  Thousands of analysts would clamor to give him hot tips.  But Buffett ignores it all.  Serene, he sits in his office, reading annual reports, newspapers, and thinking about opportunities for growth.  He isn’t drinking champagne tonight.  And you shouldn’t be either.

We are far from out of the woods.  Large companies are still laying off employees.  When we cross the 10% unemployment line, consumer spending (now down to 70% of GDP) may contract even further.  It probably should.  Consumer spending in the UK is 65% and in China it’s only 40%.

Haven’t we learned something from this crisis??  Wall Street sold the world worthless securities, trillions of dollars of wealth evaporated, and now Wall Street is cheering this “new” bull market.  Now the bulls say it’s all okay again?!

What you’re watching now is a bull market on government spending.  What you should be watching is the real report card:

• Inflation: There is $50T in unfunded liabilities on the country’s balance sheet. If the USA played by corporate America’s accounting rules, we’d be bankrupt. The laws of gravity still apply. We will experience significant inflation within 3 years.
• Job Growth: Since the start of the recession in December 2007, we’ve lost 7.6 million jobs. Millions more have stopped looking for work. The analysts keep saying this downward trend will stop. But it hasn’t.
• Innovation: The credit contraction makes it harder for entrepreneurs and small businesses to invest in growth. This segment of the economy is where a rebound will start. Don’t watch the Dow, watch small business credit (contracting) and patents filed (contracting).
• Education: The important word in “Gross Domestic Product” is product. We must have highly skilled knowledge workers to compete against other economic innovators. A third of high school students aren’t graduating. This is the HR pipeline??

Yes, we have stepped back from the abyss.  But some very smart people thought the same thing in 1932.  Then 1933 happened.  Not so fast, Wall Street…

This battle is far from over.  Let’s dig deep, focus on the long haul, and make the substantive policy and business improvements the economy needs to really rebuild.  Then, the Dow will take care of itself. 

"Art Cashin: How Today's Market Is Like Dot-Com Bubble" (CNBC Stock Blog)

The stock rally could have legs after a line of better-than-expected third-quarter earnings reports, but Art Cashin, head of floor operations at UBS, said he isn't yet convinced.

"The banquet looks stupendous, I hear the wine is great," he said. "You guys can party on, but some of us are going to sit on the sideline like wallflowers."

Cashin said he doesn't think the economy is moving as much as data shows, and he's worried there are billions of dollars in excess reserves from people not borrowing.

He added that although it's difficult to compare today's environment with any other time in history, it reminds him of the dot-com bubble, when people refused to believe the markets would go anywhere but up.

"I said, 'I've never heard of a tree growing straight to Heaven except in Jack in the Beanstalk and that was a fairy tale,'" he said. "And unfortunately [the bubble] turned out to be that way."

"Don't Trust Dow 10,000" (CNNMoney.com)

The stock market is supposed to be a leading indicator, predicting what happens next. But the rally doesn't mean the nation's economic woes are over.

As the Dow closed above 10,000 for the first time in more than a year Wednesday, economists cautioned that the blue-chip average shouldn't be seen as giving a green light to the economy.

The stock market is what is known as a leading economic indicator, as investors place bets on how strong they believe company results and the broader economy will be in the near future.

Lately, there has been a growing consensus among both investors and economists that the battered U.S. economy hit bottom and turned around earlier this year, and is now in a recovery.

The Federal Reserve said economic activity has "picked up" in its statement after its Sept. 23 meeting, and about 80% of leading economists surveyed by the National Association for Business Economics agreed in a survey earlier this month that the recovery has begun.

But even economists who agree the economy is in recovery say that growth will be slow and difficult, with continued job losses, tight credit and further declines in home prices. And even some who believe that the current Dow 10,000 level is justified say there's still a significant risk that the economy will take a step backward.

"One of the great challenges is whether consumers and small businesses come along with this recovery," said John Silvia, chief economist with Wells Fargo. "If they don't, you either sit at 10,000 or slip back to 9,500. To sustain another double-digit (percentage) gain to Dow 11,000 is asking too much from this economy and the risks we still see out there."

There are also economists who question whether the economy is truly in recovery, given that it continues to lose about a quarter-million jobs a month. They say the more than 50% rally in the Dow since it closed at a low of 6,594.44 on March 5 is only a reflection that the fear of the economy toppling into a full-fledged depression has abated.

"We're not at Armageddon anymore, so of course you should have some kind of rally," said Rich Yamarone, director of economic research at Argus Research. "But I think there's a bubble-like atmosphere going on here in the rush back to 10,000. Caution should rule the day. We're not out of the woods yet."

Several experts point out than many of the relatively strong earnings reports helping to lift the markets in recent days are being driven by cost cuts, rather than strong revenue growth that would be a better indicator of consumers and businesses being willing to spend again. If businesses keep cutting costs to make the numbers that Wall Street wants to see, that can only put more downward pressure on jobs and wages, and result in weaker economic growth or another downturn.

"The companies are cutting fat, and in many cases cutting bone and muscle. There's no organic economic growth there," said Yamarone.

Barry Ritholtz, CEO and director of equity research at Fusion IQ, said that despite their reputation as a leading indicator, the stock markets do a terrible job forecasting the economy.

"Beware of economists pointing to the stock market," he said. "The rallies tend to be false starts because it's a reaction to what came before. The sell-offs tend to be overdone because, as they gain momentum, they lead to panics."

Ritholtz said comparisons of current earnings to those of a year ago or stock levels to the lows of earlier this year greatly exaggerate the strength even the market sees in the economic outlook.

"It's like saying the Detroit Lions have better year-over-year comparisons because they're no longer winless," he said about the football team that went 0-16 in 2008, but has won one of five games so far this year. "But they're still in last place and they're not winning the Super Bowl."

Another reason that comparisons to Dow levels of a year ago are risky is that two of the more troubled components -- General Motors and Citigroup (C, Fortune 500) -- were dropped and replaced by stronger companies such as Cisco Systems (CSCO, Fortune 500) and Travelers Cos. (TRV, Fortune 500) in June.

Without those changes the Dow would be almost 100 points lower now than it is with the stronger companies, although precise comparisons are difficult since GM shares are no longer traded on the New York Stock Exchange.

"You take out the worst, put in the best, and by definition you'll get better numbers," said Yamarone.

"Why the Dow Broke 10,000, and Why You Should Still Watch Your Wallet" (Robert Reich's blog)

How did the Dow break 10,000 when the rest of the economy is in the toilet?

1. Corporate earnings are up -- mainly because companies have been cutting costs. Payrolls comprise 70 percent of most companies' costs, which means companies have been slashing jobs. In the end, this is a self-defeating strategy. If workers don't have jobs or are afraid of losing them, they won't buy, and company profits will disappear.

2. Federal borrowing has filled the gap that consumers and businesses created when the latter began to reduce their debt. Federal debt, in other words, has kept the economy from tanking. Can't keep up forever, though.

3. With such horrid employment numbers, Wall Street figures the Fed will keep interest rates low for some time, and continue to flood the economy with money. That's good news for the Street because it means money stays cheap -- and with cheap money the Street can make lots of bets on almost everything under the sun and moon. As a result, the Street's earnings are way up. But this, too, is temporary. At some point the Fed is going to worry about inflation and a falling dollar.

4. Investors of all stripes want to get in early and ride the wave. Pension funds, mutual funds, and other institutional investors figure the bull market has more oomph in it because, well, other investors will jump in. Think Ponzi scheme. Nice for now, but watch out if you're one of the last in.

In other words, this is all temporary fluff, folks. Anyone who hasn't learned by now that there's almost no relationship between the Dow and the real economy deserves to lose his or her shirt in the Wall Street casino.

Comments

[nevket240]

With all the profits (and immoral bunuses) being generated by this low volume gaming of the markets why aren't the Crime Czars on Wall St being made to buy back the "Monkeys on the Taxpayers backs". I cannot see how they have unloaded Hundreds of billions in bad bets onto the taxpayers but can pay themselves hundreds of billions in bonuses.
O'Bummer, chasnge you can believe in. Yeah, right. Chump Change$$$$
regards

[HSpencer]

The markets don't matter as they are so easily changed and up and down depending on what benefits who.
What matters is the American Citizen. Markets be damned if he has no job, is in foreclosure, has no Christmas spending, can't make the car payment(s), boat payment, jet ski payment(s),private school payment, big screen TV payment, Credit Card(s) payments, Department Store payment(s), or maybe he does still have a job but is so overextended he could not make the payments anyway, job or no. How many Visa, Discover, Citi-Bank, Captital One, is he juggling?
I doubt if he even knows for sure the monthly total tab. Many of them are afraid to even add it up. Prosaic, Beer, D_I_O_V_O_R_C_E (becomes final today), and spousal abuse springing up.
(Stopping here, my head is beginning to hurt just thinking about it). And--The steep peaked roofed McMansion is leaking from the last high windstorm.

[Tradermark]

Scary that Reich makes so much sense :)

[roger]

Money creating money
in 2006 the financial sector produced 40% of all
the profits of domestic industry, clearly the
financial Oligarchs are doing a fantastic job.
If you understand the implications of such a system
you should not have any doubt where Wall Street is
headed.

[www.facebook.com/profile.php?id=1418602343]

Capitalism will always bounce between boom and bust cycles. Our free markets unfortunately, will move based on which emotion prevails in Wall Street AND Main Street.

We've recently experienced unprecedented fear that drove the SP500 down 56.8% (peak to trough). A plunge second-only to the great depression. (Please, i make NO generalized comparisons of this current recession to the 'Great Depression'). Sadly enough, there's been few reminders shared with investors as to why, for example, the recessions in 1980 and 1981-1982 saw a fraction of the market drop we just experienced. During that period national unemployment peaked at 10.8%, inflation's peak was 15% & the Prime Rate saw 21.5% (remember 19% home mortgages). However, cell phones, pc computers, and the internet DIDN'T EXIST. During these years, cable TV was still in its infancy. (It wasn't until the 'Cable Act of 1984' that cable was deregulated and expansion then saw its explosive growth in America).

Simply put, we weren't slapped about the face, 24 x 7, with constant 'armageddon' scenarios of where America was headed. Hundreds of media pundits, on a wide variety of dedicated 'financial news' cable channels, often provided increasingly sensationalized stories using partial information to support their opinion. Let no one forget, all of the major media outlets (ABC, CBS, NBC, FOX) are FOR-PROFIT companies with shareholders expecting a return on their investment. Each of which continuously strives to increase their viewership (a great example of capitalism). However, since greater viewership numbers can pull in a larger amount of available advertising dollars, 'sensationalization' of information can pull those viewers to you media outlet.

America has been thru crises of 'historical proportion' many times over the past century. Each time we said to each other, "its never been like this before". But each time, we rally together continuing to thrive and grow stronger. The truth lies somewhere midpoint of the extreme pessimist and the exaggerated optimist.

[Mark G.]

Excuse my loose thoughts and lack of total recall. Earlier this decade, Bernanke gave a speech in Japan. Words to the effect of setting price targets based on desired inflation rates, other sectors will then chase that price target and inflate accordingly. The last figures I've seen on trading volumes from March of this year to now, volumes are near 50% less of last years numbers over the same time frame. Many institutions have become bank or financial holding companies allowing them access to the Fed's discount window, tax payer money basically for free,at current rates.

Have the equities markets become the centerpiece for Bernanke's great experiment? Are price targets applied to equities markets with the belief that other aspects of the economy will chase those prices? Is the scientist peering down on the lab rats as he lays only one trail of cheese towards the direction the he desires the lab rats to scurry towards? If so, aren't the results of the entire experiment susect at best?

[jmf]

Moin from Germany,

Colbert / The Money Shot.....

http://www.colbertnation.com/the-colbert-report-videos/252724/october-15-2009/the-money-shot

Have a nice weekend......

[Rocky]

Was all that talk about "69" on the Colbert clip? I guess all those out of work Bush backers can take comfort in the fact that gay couples still can't file joint Federal income tax returns.

[mthomas]

Very good point about the recalibration. But it is very difficult to time such an event. That is why going forward, even though I am pretty bearish on the markets now, I think it is still a safer play to stay long gold than to short the markets, because I feel I can still come up with a stronger bullish case for gold than a bearish case for stocks due to all the government support and liquidity. Over the past few days I've read several good articles at http://www.goldalert.com/gold_news.php that discuss the govt and Federal Reserve's specifically, easy monetary policies in order to try to prevent any sort of deflation from occurring. I think these articles are very useful for any investor because they help to explain the investment implications for the dollar, the gold price, and gold mining companies who should continue to benefit from the Fed's inflationary programs. In the end the market will catch up to the fundamentals, but it is very tough to time such a thing in my opinion.

[roger]

(Capitalism will always bounce between boom and bust cycles.
But each time, we rally together continuing to thrive and grow stronger).
Always? no such thing, stronger? more like weaker!
Each crisis signals a profound change in the productive sector and in
social relations both local and in international sphere, now its also includes
the ecology section,.the productive sector besides been automated is
now located in China, the center of power as been shifted from the manufacturing
section to the financial one. Capitalism to survive must on a perpetual basis,
lower the cost of labor,increase consumption,find new markets and monopolize
the earths natural resources,no better recipe for a deadly end.

[paolo]

I think the market has been helped to move to the upside both trying to improve the general sentiment among the public and through injection of government money into the financial system. Ok, they have made it. Now what? The public feels much better about their savings. But will the economy follow up? If it does not let's prepare for another crash. In general, however, I think prices will correct from here. Equities have anticipated too much the recovery.