Wednesday, October 14, 2009

Dow 10,000: a Charade

"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." – Rich Yamarone, director of economic research at Argus Research

On Wednesday, the Dow Jones closed over 10,000 for the first time in over a year.

Don't believe the hype.

The US economy has suffered a real estate collapse, a banking crisis that led to a near systemic collapse on a global scale, a credit crisis, the worst economic downturn since the Great Depression, and an unprecedented global recession.

Because of all that, the stock market rightly crashed during the winter and spring, bottoming out at 6469 on March 6 — the market's lowest level since November, 1996.

Just eight months earlier, the market had been over 11,000.

But now, despite the fact that the US gross domestic product and consumer spending are declining, the stock market is in the midst of an unfathomable rally. It has soared more than 50% since March, while the economy has remained in a tailspin.

This makes absolutely no sense. Consumers are deleveraging and the flow of credit has slowed. One in five Americans is unemployed or underemployed.

The government's U-6 unemployment figure — the true jobless rate — now stands at a whopping 17%. Yet, the government recently admitted that it has been systematically underestimating job losses for the last three years.

Additionally, one of the President's closest economic advisors, Austan Goolsbie, has noted that roughly 1% to 2% of our population's unemployed are downright unaccounted for on a monthly basis due to a variety of factors. And those who run out of unemployment benefits are no longer counted among the ranks of the unemployed.

With all of this in mind, how could the Dow have possibly surpassed 10,000?

It's due to a herd mentality, not fundamentals. Investors are bidding up the stock market in a delirious frenzy, hoping to recoup previous losses, or get rich buying at what is perceived to be an opportune time. Hey, everyone else is buying, right?

Simply put, lots of new money is flowing into the stock market and pushing up the average. It's not because a recovery is underway. And this means a lot of people stand to get burned.

The relatively strong earnings reports that have lifted the markets in recent days are being driven by cost cuts and layoffs, not strong revenue growth. But that will only put further downward pressure on jobs and wages, and result in weaker economic growth and a deeper downturn.

The merry-go-round will end up right back where it started.

Wall Street is a pretty poor barometer of the economy's performance since it is simply a bet on the future performance of a select group of companies listed on three stock exchanges. Additionally, the majority of the country doesn't have any direct investments in the stock market.

The Dow Jones is currently trading at 28 times earnings. The S&P is even worse; historically, its median P/E is 16,, but is now trading at 139 times earnings. That alone is reason not to invest. It is simply unsustainable.

Yet, the fools have rushed in, enthusiastically.

But the institutional investors, the real market movers, will soon take their profits and quickly pull the escape lever. The herd will try to follow, but not all of them will be able to squeeze out the emergency exit at the same time. There will be a bloodbath.

By some estimates, "high frequency trading" is responsible for close to 70% of all volume in US markets. Computers can track hot stocks and immediately buy up all available shares, subsequently selling them at higher prices. Millions of shares can also be dumped in just milli-seconds.

The markets are manipulated. Sadly, there is a very heavy price to be paid because of this. Billions of dollars will be lost, yet again.

1 comment:

  1. Not bad...but i can see dow 11,000. I agree that the jump in GDP is due to cost cutting measures but i would contend that their is now a huge disconect between the health of america and the markets. This rally is more institutionally driven than investor joe and it remains to be seen how many people will be truely hurt when the institutions take profits. I don't think investor joe has actually gotten off the sidelines yet.