I ended my commentary last month with the sentence, “Hopefully good economics will prevail this time around”.
That sentiment became more of an open question following the unexpected decision by the British electorate to leave the European Union. The immediate market response was to run for cover. The British Pound fell precipitously, stocks around the world moved sharply lower, government bonds and gold rose. The “fear trade” was on.
Bull market roars on
However, once again this stock bull market roared with the resilience that has been its hallmark since the lows of 2009. US stocks not only recovered from Brexit but sit just a whisker away from an all-time high. Why? Because of better than expected economic news.
First, the ISM Services report showed a bigger expansion in the service economy. Then Friday’s employment report indicated a sharp rebound in jobs from May’s almost zero employment growth.
Despite the sharp rebound in stocks, pessimism still abounds. Most commentators I saw on CNBC and Bloomberg, as well as in this week’s Barron’s, still see stocks having difficulties sustaining these levels.
On the CNBC show Fast Money, the pundits were tripping all over themselves trying to rationalize their bearish and wrong calls. Most of the reasons why the CNBC and other pros feel the market is headed lower are the same arguments that have persisted throughout this long bull market – high valuation, slow global growth, European crisis, China crisis, and declining bond yields.
All these factors are in and of themselves real concerns. The problem for the bears is that the markets are extremely complicated. There are a large number of factors at work to determine prices.
Making the task of predicting stock prices even harder is the fact that in determining prices, the market has to not only interpret the factors in the present but also make some guess as to the outcome of these and new factors in the future.
Is the decline in interest rates signaling a recession or are the low rates a reflection of Central Bank buying and traders who keep buying in an attempt to front-run” the Central Bankers?
Is then the sentiment in the market today too pessimistic about the future of the economy?
Market climbs the wall of worry
So far, the pessimism has been too great and the market has climbed the “wall of worry”.
Smart Indices or Factor-based Index Funds attempt to sort out the factors in such a way as to improve on the idea of a passive index. Again, is it really possible to
1) identify all the relevant factors,
2) pick the right combination of factors, and
3) properly assess their outcome in the future?
The jury is still out on these products but they are nonetheless being heavily marketed to the public.
Brexit added a new set of questions for the markets to deal with and resolution will probably take some time as the UK and EU negotiate a new path forward.
Despite the news we can not discount the power of sentiment to be a contra-indicator.
— Ian Green, Pendragon Capital Management
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Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.