What’s Going On?

When a significant trend change occurs in equity markets, the immediate response is usually a mix of confusion and often futile attempts to rationalize the occurrence. This is true regardless of whether the trend change was in your portfolio's favor or against it.

By Barry Ritholtz
November 15th, 2012, 7:22AM
The Big Picture

Whenever a significant trend change occurs in equity markets, the immediate response from most quarters is a mix of confusion and often futile attempts to rationalize the occurrence.

This is true regardless of whether the trend change is in your portfolio’s favor or against it. A heady mix of wishful thinking and fear get trotted out with various degrees of success, provisionally being accepted as pearls of wisdom before events disprove the thesis and lead to its discarding.

Financiers on Wall Street attempting to describe the day to day action oft resemble the parable of the six blind men describing the elephant.

Changes in market action send all scurrying back to the comfort of their discipline; each describes what they “see” in relationship to their school of thought:

• The Fundamentalist sees the market in terms of earnings and perhaps guidance;
• Technicians sees trend line breaks and H&S patterns.
• All of the Macro guys see global economic activity, including recession in Europe and slowing in Asia.
• Value Investors sees stocks as relatively cheap, with moderate P/Es and dividend yields.
• Monetarists cannot see anything but Fed intervention and currency action.
• Behavioralists watch the VIX, Put/Call ratio, percentage of stocks over their 200 day moving average, amongst other indicia of fear and panic.
• Political economists cannot see past taxes and the fiscal cliff.
• The analysts who prefer a fusion of schools of thought runs into the possibility of information overload and false signals.

While each manages to describe a small portion of what is going on, they do so with only limited success. Regardless of your preferred school of thought, you should realize that any single discipline cannot pull together a grand vision of what is going on. Hence, during market turmoil, we see confusion compounding the volatilty.

The Minsky moment — following a long period of prosperity and increasing values of investments, which has encouraged increasing amounts of speculation, often using borrowed money — is not merely an economic phenomena. Prosperity leads to complacency, leading players to take more risks in order to achieve greater results. The subsequent dislocations that occur are all but inevitable.

We have had a 100% rally off of the March 2009 lows, driven by many factors. By my reckoning, that should have been a 70% or so move, in light of the 57% collapse that preceded it. As the more organic elements (psychology, valuation, mean reversion) began to fade, the artificial factors of the Fed (QE, ZIRP) kicked in. The 37% or so those helped to drive also now appear to be fading.

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