"Anyway, no drug, not even alcohol, causes the fundamental ills of society. If we're looking for the source of our troubles, we shouldn't test people for drugs, we should test them for stupidity, ignorance, greed and love of power."
- PJ O'Rourke
- PJ O'Rourke
Market/Economic Climate
There is an old saying many successful investors/traders we know live by: it isn’t the news that is important, but the reaction to the news. What does this mean? Monitoring how financial markets react to both positive and negative news can be instructive as to how market participants are positioned in aggregate. For example, market bottoms are often put in when horrible news is announced and the market rallies anyway. The rally continues to defy bad news and investors grow frustrated as the rally “doesn’t make sense”. This is what we call “crawling the wall of worry”.
After a period of time, the wall of worry slowly transitions as the news back drop begins to improve. Investors begin to convert from worrying about losing money to concern that the train may be leaving the station without them. Among professional investors, what we call the “viagra effect”, begins to kick in – portfolio managers begin to buy more volatile stocks due to performance anxiety, as their performance lags major stock market averages. This manifests itself in a narrowing of market leadership among what are called higher beta, or more volatile, stocks.
Such behavior serves to create a significant momentum in markets, which can often last longer than many can expect. TEAM has certainly been guilty of this error in recent weeks, as the stock market’s persistence to the upside has been unrelenting. We’ve chronicled in recent weeks the various chinks in the market’s armor as it has marched higher. For example, the increase in prices of late has been driven by an absence of selling rather than a continuation of intense demand. From the data we have seen, short sellers have largely exited the game for now, which lifts a natural source of supply.
This week brought with it several more signs of concern. First and perhaps most importantly, the market reacted poorly to good news. The monthly employment report was announced on Friday morning, and job losses came in dramatically below the consensus forecast. TEAM has a long and consistent history of criticizing these ridiculous exercises in statistical fantasy and Friday’s employment figure didn’t disappoint in this regard. The infamous birth/death adjustment the government uses to try and guess how many jobs were created or lost by small business added 220,000 jobs for the month. Such an assumption is just flat out ridiculous in our opinion.
Despite the goofy nature of the number, the markets reaction to it was instructive. After initially bouncing sharply when the figure was announced, the market exhausted to the upside and reversed to end the day down marginally. The market had been down a good more earlier in the day, but the recent trend of investors buying any and all dips was at play once again.
Another data point that crossed our desk this week that is concerning has been the explosion in speculative trading in OTC stocks in recent weeks. As reported by Sentimentrader.com, the share volume of penny stocks has exploded in recent weeks. This has historically been a sign of excessive speculation in the past and has often occurred prior to market corrections.
With sellers being very weary, even modest levels of demand can result in significant short term market support. We remain nervously constructive on the markets over the intermediate term, but would stress the word “nervous” at this point. The market has not yet done anything of significance to warrant major concern, but we continue to retain a modest amount of defensive hedges for some protection. Historically, markets being driven higher by an absence of sellers often reverse violently when/if sellers return. After a very large run higher in commodity prices during May, clients should be prepared for portfolio volatility in the coming weeks.
After a period of time, the wall of worry slowly transitions as the news back drop begins to improve. Investors begin to convert from worrying about losing money to concern that the train may be leaving the station without them. Among professional investors, what we call the “viagra effect”, begins to kick in – portfolio managers begin to buy more volatile stocks due to performance anxiety, as their performance lags major stock market averages. This manifests itself in a narrowing of market leadership among what are called higher beta, or more volatile, stocks.
Such behavior serves to create a significant momentum in markets, which can often last longer than many can expect. TEAM has certainly been guilty of this error in recent weeks, as the stock market’s persistence to the upside has been unrelenting. We’ve chronicled in recent weeks the various chinks in the market’s armor as it has marched higher. For example, the increase in prices of late has been driven by an absence of selling rather than a continuation of intense demand. From the data we have seen, short sellers have largely exited the game for now, which lifts a natural source of supply.
This week brought with it several more signs of concern. First and perhaps most importantly, the market reacted poorly to good news. The monthly employment report was announced on Friday morning, and job losses came in dramatically below the consensus forecast. TEAM has a long and consistent history of criticizing these ridiculous exercises in statistical fantasy and Friday’s employment figure didn’t disappoint in this regard. The infamous birth/death adjustment the government uses to try and guess how many jobs were created or lost by small business added 220,000 jobs for the month. Such an assumption is just flat out ridiculous in our opinion.
Despite the goofy nature of the number, the markets reaction to it was instructive. After initially bouncing sharply when the figure was announced, the market exhausted to the upside and reversed to end the day down marginally. The market had been down a good more earlier in the day, but the recent trend of investors buying any and all dips was at play once again.
Another data point that crossed our desk this week that is concerning has been the explosion in speculative trading in OTC stocks in recent weeks. As reported by Sentimentrader.com, the share volume of penny stocks has exploded in recent weeks. This has historically been a sign of excessive speculation in the past and has often occurred prior to market corrections.
With sellers being very weary, even modest levels of demand can result in significant short term market support. We remain nervously constructive on the markets over the intermediate term, but would stress the word “nervous” at this point. The market has not yet done anything of significance to warrant major concern, but we continue to retain a modest amount of defensive hedges for some protection. Historically, markets being driven higher by an absence of sellers often reverse violently when/if sellers return. After a very large run higher in commodity prices during May, clients should be prepared for portfolio volatility in the coming weeks.
Humor for the Weekend
This graphic comes via www.theonion.com
Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.
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