Friday, June 11, 2010

Markets and People are all Irrational from Day-to-Day - Version .002

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Markets and People are all Irrational from Day-to-Day.

Version .002 re-print, dated 06.11.2010

Dear Friends:

The fact is that financial markets and people are irrational from day-to-day.

A rumor (mere words without supporting facts) can cause the Dow Jones Industrial Average or the NASDAQ to rise or fall. An official pronouncement from a government agency or even the CEO of a major corporation can generate incredible swings in the capital markets.

When the markets rally for a day or several days, these "recovery-like" responses are either:  1) knee-jerk reactions to any sign of optimism which affirms or feeds confidence that "the troubles are behind us, so let's get back in!", 2) some-savvy bargain hunters or strategic purchasers buying cheap stocks and bidding the volume and prices up as they do this, 3) short-term trading activity by big-time institutional gamblers.

When the markets and indexes start to fall after a brief rise, this is ususally caused by either: 1) frightened investors selling out at a loss and investing their cash in other investment alternatives, or 2) profit-taking by a select few futurists who see an opportunity to sell their shares and get out while they can, sometimes to minimize long-term losses, and sometimes to lock in short-term gains based upon temporary rises caused by unfounded optimism.

Some bad news by noted economic analysts, financial commentators or disappointed "pundits," can cause a calamitous sell-off and decline in these same market indexes. The markets and indexes are incredibly hyper-reactive to any bit of news. And like a children's circle game of "telephone," little rumors rapidly turn into certain knowledge.

I would personally like to wait for the roulette wheel to stop before I assess my victories or losses. I am more apt to act on a pattern of corporate performance results than on rumors and brief waves in the capital markets. Waves and rollercoasters tend to make me seasick and disoriented.

Volatility is never healthy in capital markets except for those who make their money specifically based upon fluctuations, and those who make their fees based upon transactional volume.

The proof of any genuine recovery in the capital markets would have to be evidenced by 1) a sustained and mounting rise in inflation-adjusted stock prices supported by 2) a parallel and consistent increase in inflation-adjusted earnings per share in the traded companies as well as 3) an increase in the fair market value of each constituent company's assets minus its actual and contingent liabilities...this is actually a decrease in leverage, and stable or rising revenues from ordinary operations. These same conditions also happen to coincide with the fundamentals of any sound company, as well.

I do not expect that kind of recovery in the capital markets either in the US or elsewhere in the world for another year or two.

Any market or index rally supported by a news story, a legal settlement or other isolated event in a single company, commodity or sector is just the fish of the day -- usually a red herring. These are not productivity-based or value-based. They are short term, reactive fluctuations.

An example follows, excerpted from a preview of a New York Times article: 

Breaking News Alert
The New York Times
Thu, June 10, 2010 -- 4:08 PM ET
Stocks Rebound on Positive Economic News; S and P. 500 Climbs Nearly 3%

Indexes on Wall Street rebounded on Thursday, closing up
almost 3 percent, on a day fueled by bargain hunting and some
positive economic news.

Asian and European shares were also higher, and the euro
regained some ground.

Trading picked up in the last hour, pushing up the Dow Jones
industrial average 273.50 points, or 2.76 percent. The
broader Standard and Poor's 500-stock index rose 2.95 percent,
while the technology-heavy Nasdaq was up 2.77 percent.

Read More:

You may ask me, "Douglas....isn't this good news?" I would have to answer, "No. Not at all. This is just proof of people's irrational day to day behavior. It might even reaffirm people's traditional susceptibility to silly stories or even a form of "whistling past the graveyard."

I remain throughly unconvinced until I see the underlying economic fundamentals change in the capital markets.


Douglas Castle

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