Monday, September 05, 2011

The Point of Maximum Pessimism

_Kris_SayceGuest Post by Kris Sayce of Money Morning Australia

Phew! What an exhausting month.

On the last day of July, the S&P/ASX 200 index closed at 4,424 points.

On 9 August the index reached an intra-day low of 3,765 points.

At the close of trade on Wednesday the index closed at 4,296.

As you can see on the logarithmic chart below, the stock market action this month has been the most volatile this year:

stock market chartSource: CMC Markets Stockbroking

In fact, for a similar sized percentage move you have to go back to April last year. Funnily enough, that too marked the approximate end of a period of U.S. Federal Reserve money-printing.

And now the market is waiting for the next central bank move.

Not surprisingly, the market has gone all topsy-turvy.

What’s good is bad, and bad is good

Economic news that’s normally seen as positive is now seen as negative. Why? Because the market fears it may stop the Fed from printing money.

Not only that, but bad economic news is cheered… because it increases the chances of money-printing… and that’s seen as a good sign for the markets and the economy.

For example, this from Bloomberg News:

The dollar rallied, Treasuries rose and U.S. stocks swung between gains and losses, as the manufacturing report bolstered optimism in the economy while dimming prospects for more monetary stimulus from the Federal Reserve.

It’s crazy. Positive news should be positive for stocks. But these days, that ain’t always the case.

The only explanation we can come up with is this…

A genuinely self-sufficient market will take months and possibly years to recover and grow. But – and here’s the key – it will be sustainable growth.

By contrast, a central-bank-induced “recovery” will hit the markets right now, like a big shot of coffee. But – and here’s another key – it’s not sustainable. Just as the effects of previous stimulus soon wear off, so will this one.

And traders who have gotten into the market on the basis of more stimulus know this. That’s why they’re getting out on any signs of positive economic news.

However, they needn’t be so nervous. Because we’ve got some news for them…

Fed meddling is certain

Action by the U.S. Federal Reserve is almost guaranteed. Meddling is what these guys live for. But we understand traders’ nervousness. When they’re punting with huge leveraged bets the last thing they want is to be in the market while other traders are selling out.

That’s what’s making the market hyper-volatile.

And if you’re in any doubt about the impact of stimulus on the real economy, it’s worth noting the following quote from the Financial Times. Because not everyone is happy about the outlook for the economy:

In many countries, the surveys of purchasing managers produced the lowest readings of manufacturing activity, orders and jobs since mid-2009, when the world economy was crawling out of recession.

To us, the situation is clear: for as long as policymakers continue to meddle and try to boost the economy, the longer the economy will stay depressed.

Yes, it may help the stock market in the short term by artificially inflating prices. But long term, it will do no more than disappoint investors.

And eventually investors will get so used to the post-stimulus disappointment they’ll forget to get excited about the stimulus beforehand. That’s when you’ll know the market is at the depths of the depression.

And that’s when the market will be at a genuine bargain price. Famous investor John Templeton only bought stocks when the market reached “the point of maximum pessimism”.

In 1939 it reached that point. He bought stocks. He made a fortune. But not straight away. It took time. Central bankers aren’t interested in taking time. They’re trying to bag a quick fix.

And that’s what’s creating the volatility and distortions in the market.

So right now, some individual stocks are at “maximum pessimism” prices and are worth buying. But the market as a whole isn’t.

That will only come when investors are no longer fooled by the magic charms of central bankers.

Until then, the action you’re seeing now is nothing more than a trading market. That’s great for traders. And great for punters. But it’s not so good for the conservative investor who’s just trying to save for retirement.

And by our estimates, it seems the market is set to stay this way for a while yet.

Cheers.
Kris
Money Morning Australia

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