Unemployment up, consumer confidence down.
The result?
The stock market goes up.
To the novice investor, or someone without an interest in financial markets, it doesn’t make sense.
This apparent paradox reminds us of a lunchtime chat we had 12 years ago with the managing director of a small Aussie medical company.
Despite being a PhD boffin, he didn’t understand how markets work either. We tried to explain it. But it wasn’t sinking in. But really, it’s quite simple…
The truth is that consumers and most of the general public are reactionary. They observe what’s going on around them, or what others tell them is going on around them, and then they assume things will continue that way into the future.
If things look fine today they assume they’ll be fine tomorrow. If things look bad today they assume they’ll be bad tomorrow.
That’s what makes most people bad investors.
We bring this up after stumbling across a five-day-old article in the Sydney Morning Herald.
It was the usual dull affair, but two paragraphs stood out from the dreary reporting:
‘The Westpac/Melbourne Institute consumer index slipped for the third-straight month for its February reading, as Australians’ expectations about the economy over the next year fell to the lowest level since March 2012.
‘Consumers’ expectations for the next five years along weakened to levels not seen since February 2009, the survey found.‘
Most Investors are Terrible Investors
It just so happens that the dates mentioned in the Sydney Morning Herald coincide with the date that markets were ready to hit rock bottom just before a major stock rally.
February 2009 was of course the month before stocks hit the bottom after the 2008 financial meltdown. From there the Aussie stock market gained 57.3% over the next year.
One tiny natural gas stock we tipped in the December 2008 issue of Australian Small-Cap Investigator had gained 458% by the time we issued a sell recommendation in June 2009…barely four months after consumers were reported to be at their most pessimistic.
It was the same in March 2012. If you recall, the stock market had been in decline since early 2011. This was when Greece and the rest of Europe were on the verge of collapse, and the US Federal Reserve’s first money-printing program (QE1) had ended.
According to the Sydney Morning Herald, that’s when consumers were again pessimistic about the future.
The outcome? Almost exactly one year later the Aussie stock market had gained over 20%. But the consumers and investors who were pessimistic about the future missed out on those gains.
That’s why most people make for terrible investors.
When Things are ‘Less Worse’, Stocks can Rise
The important part is that the depths of the stock market didn’t happen until after these bearish consumer outlooks.
It’s important because as the stock market falls it confirms their bearish view – it’s ‘confirmation bias’.
The sad thing is that when the market turns upwards as it did in March 2009 and May 2012, those with a pessimistic view don’t believe in the recovery. They think they’re right to be negative about the outlook, and they’ve got the previously falling market as proof.
Except the stock market didn’t agree.
As we’ve mentioned before, stock prices reflect future expectations of profits. If profits are better than expected, then stock prices should go up. If profits are worse than expected then stock prices should go down.
The key word is ‘expectations’. It doesn’t mean that the economy has to be powering full steam ahead. It just means that the economy may only have to be ‘less worse’ than expected in order for stocks to rise.
That was the point the PhD wielding managing director couldn’t understand as we stabbed at our food with chopsticks at Chinatown’s Dragon Boat restaurant all those years ago.
He just didn’t get why a stock price would rise when a company had just announced a loss. The answer of course, was that the loss was less than investors expected and so the outlook for the company was potentially better than expected.
But it wasn’t sinking in. So we gave up and went back to stabbing at prawn dumplings and pork buns…
Slowdown? What Slowdown?
It would be great if the economy was in the sweet spot where unemployment fell, consumer confidence rose, and asset prices climbed nicely.
However, that’s also exactly the kind of market that should make you cautious about the future. Because when everyone feels confident, it generally means that stock prices are priced for perfection.
In that instance investors start to have unrealistic expectations about where stocks could go next. That’s when you start to get crazy stock valuations and commentators begin saying that stock prices can never fall.
That’s the exact opposite of where the market stands today. Unemployment is the highest in four years, the local car making industry is almost dead, and amazingly, analysts are still fretting about a slowdown in China…even though China has just imported a record amount of raw materials during January. (That has resource analyst Jason Stevenson smiling from ear to ear. You can see why here.)
In short, if you’re after a sign that the market is primed for another bull market run, just ask the average consumer. If they tell you the outlook is terrible, there probably hasn’t been a better time to buy stocks in the last five years.
Cheers,
Kris.
Special Report: 2014 Predicted
