The always intellectually provocative Howard Simons had a great column in Real Money today dealing with the question of can stocks decline in a rising economy. The answer of course is yes, sometimes violently, see 1987. The truly intriguing aspect of his column however dealt with the correlation, or lack thereof, between the stock market and GDP. There are periods when they track closely and periods when they diverge. The question is whether or not the lack of correlation can be explained. If the failures are caused by random factors, one would not expect there to be any pattern in the residual between stocks and GDP. He posted a fascinating chart that showed exactly the opposite. Over a roughly 40 year period, the residual traces out a clearly cyclical or sine wave pattern that would make any trend follower drool. Following a long period when stocks outperformed in the great bull market, we are now in one of the underperforming periods. He promised to provide an explanation for this pattern next week. He did appear to rule out interest rates or currency factors as causes, since they did not trade freely until the middle of this period. I have never been a big fan of inter-market analysis, but I can hardly wait for his conclusion.
I hopw it includes the simple situation of money fleeing the market and driving it down. Likewise, the simple situation of money entering the market and driving it up. DJ would be at 11,500 if it were not for attrition of money. Good luck on your quests.
Discounting. Clearly the author doesnt really grasp market dynamics. For example, for the last couple of weeks during the midst of earnings seasons, the market has been pretty tepid despite more than favorable numbers. Leading indicator came out as expected; this would have push the Dow at least 50 point a few month backs. Believe or not the best time for stock is during the leg BEFORE The bottom of the recession. Moreover, what the author has postulated can be explained by the Q-ratio. In fact the fluctuation in those residuals can be approximated by the Q-ratio. P.S. ANYONE KNOW ANY GOOD (FREE) NEWSLETTER that can explain financial markets..... Most like money columns are geared towards Laymen ... no offense. I just need some hardcore stuff.
A simple reason is market pyschology. It's really not that complicated. GDP and stock prices generally go hand in hand. If the economy is down, profits would be down, and thus stock prices. But, and this is a big but, market prices are driven by something that GDP is not. Namely human emotions. Thus in the 20's, people get too excited by stocks, prices go up faster than GDP, people expect perpetual increases in profits indefinently. The fabled new economy. Then it crashes, people become deeply pessimistic over stocks, it gets burned into their pysche not to buy stocks, thus you have the "lost generation" of investors. Profits were rising in the 40's, yet it took until the 50's for the DOW to recover. You're seeing the same thing in Japan. The Japanese economy has shown a net gain in GDP growth from 1990 until now. Yet prices are much lower because things got so inflated on the upside. You'll see parabolic rises in stock charts, but not in GDP charts. Things get out of whack then re align.
Simons wrapped up this discussion with his column today, although the answer was somewhat less than fully satisfying. Turns out the previous post by jbtrader nailed it pretty close. As Simons puts it: "Over the past half-century, we cannot demonstrate stable causal links between total return on stocks and GDP, after-tax profitability, capital expenditures or inflation. All the usual suspects are hereby released on their own recognizance. The best model is the least-satisfying and most-circular one: Stocks will rise so long as people are willing to own them, and nothing more. "
Money in= scarcity of product. Money out = oversupply of product. sorry I was unable to communicate it before...lol.
From Simons column: "The late Nobel laureate James Tobin created a measure now referred to as Tobin's Q, which is the ratio of the market value of capital to its replacement cost. A Q-statistic greater than 1.0 indicates stock prices are overvalued relative to the replacement cost of their underlying assets, and that leads to a surge in new stock issuance. This wave of new investment capital drives down returns and leads to both overcapacity and lower stock prices. "