| Bull Market: Reality, Sucker Rally, or Herd Mentality? |
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| Sunday, 15 November 2009 23:54 | |
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The financial headlines this week were all thumbs up: DOW hits 13-month high! Up 136.49 points to 10406.96! A robust sign of economic growth! Yes, that all sounds tempting, but what does it really mean? Is it a signal to jump back into the market with both feet? Those prices must be signaling a "now or never opportunity," right? Take a deep breath. Lest we forget, this new high is still nearly 4,000 points lower than the record closing high of 14,164.53 on October 9, 2007. The sting of those losses has left a lot of us playing catch up and applying balms of hope to our wounds. Is this current bull market a true sign of recovery and opportunity, or simply a classic sucker rally in the middle of a bear market? We can't answer that, but we do know that this uptick creates dangerous and fertile ground for victims of herd mentality. If you need a refresher course on just how susceptible we are to getting caught up in such madness, you'll find a whole chapter filled with examples in our book The Big Gamble: Are You Investing or Speculating? Think you're savvy enough to avoid such folly? Well ask yourself if you've ever succumbed to advertising hype or subtle marketing ploys that lured you into overpaying for a product . . . all because you wanted to believe the claims were true. Or have you ever bought securities that you subconsciously felt might be were overvalued, but the price kept moving up and the herd instinct was too much to resist? Taking a step back from the hype, we'd like to remind you that this recent Wall Street market move shouldn't surprise anyone—we're still in a quarter that's full of surprises. This is when many companies release their numbers that tout positive earnings. But look closer. Are those numbers based on actual revenues, or are they the result of recession induced major cost cutting? Chances are you didn't see any stellar numbers listed in the revenue column, but cost cutting is the main factor in staying afloat for many companies. If you wait one more quarter, you might get a more accurate picture of how these companies are faring. Meanwhile jobs are tanking, consumers are not spending, and taxes and health care costs—in spite of so-called reform—are going to rise. The economy is still weak and if companies aren't able to book revenues, how will that result in hiring, trickle-down spending, and a sustained bull market? But then again, if we base our investing solely on company revenues, how do we know what's really behind those numbers? We've already reported on the House of Cards known as theCredit Default Swaps. They were deemed the evil force underlying the recent economic disaster. But guess what? After all the finger pointing, the tongue lashings, the hues and cries of foul play that led to the eventual promises of major financial reform . . . these exotic investment vehicles are back! And still nobody understands them! Tim Geithner recently said, "Everybody understands that we cannot have our financial system go back to the practices that brought this economy to the brink of collapse." Yes, we agree, yet Wall Street is creating more devious and risky investment vehicles, obscure derivatives are being traded again, bonuses are bigger than ever, and bank lobbyists are outspending each other to kill reforms. So, how does that Wall Street rally look to you now? Is it based on anything viable or reliable? Is this the time to buy in? Consider these facts: People who invested in the stock market just prior to the crash in 1929 did not recover their losses until Dwight D. Eisenhower became president, 1953-1961. Do the math! And people who invested in 2000 or early in 2007 will have to wait until the market jumps another 40 percent before they are whole again. In view of all these facts, how can you gauge when the time is right for you to invest, or as we prefer to say, speculate? What really makes the market react? How do you sort through all the hype and make sense of it all? If we can get technical for a moment, Milton Friedman argues for an efficient markets hypothesis, or EMH, which says that in any free market, competition among investors and entrepreneurs invariably drives prices to their correct levels and that free markets always make unbiased forecasts, even if they prove incorrect. EMH does not say the market price is always right, merely that it reflects all known information at any given moment. But EMH is theory and just theory. In the real world, human action and reaction is based on countless motives fraught with emotions that don't give a hoot about theory. We are a reactive and sometimes irrational species by nature, especially when our survival and financial security is at stake. The stock market is driven by our hopes and fears, and when greed and fear enter the equation, it tends to make us behave in a way that doesn't fit the EMH model. Or any model for that mater. When enough of us act out our hopes by jumping on the same stock bandwagon that everybody else is jumping on . . . well . . .we sometimes wonder if Friedman has ever heard of herd mentality. Read more in our bookThe Big Gamble: Are You Investing or Speculating? |
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