Weekend Economists Go Through the Looking Glass May 17-19, 2013

[Demeter]

14. Dow 15,000 is only the beginning; Commentary: Why investors distrust the rally By Jeff Reeves

http://www.marketwatch.com/story/why-dow-15000-is-only-the-beginning-2013-05-13?siteid=YAHOOB

There’s a rally going on. Why are so many people worried? It’s probably not an exaggeration to say that this is the most hated stock market rally of all time. The simple facts that the S&P is up about 17% year-to-date or that the major indexes are setting new highs should prompt immense celebration across Wall Street. But there’s no party. Negativity and doubt persist. I personally believe the front-loaded returns of 2013 are ripe for a brief pullback, but I am very bullish longer term and I’m staying fully invested. My reasons aren’t particularly unique, but here are the biggies:

Fair to attractive valuations

There are many data points here that people can parse as they see fit. Mine is that the S&P’s trailing P/E ratios haven’t been below 13 since 1989 — and since January 1990, the S&P’s median P/E is about 20 and the average is 25. We are currently at around 18. You can say I’m cherry-picking, but I would assert I am favoring the era of computers over the era of the horse and buggy.

Politicking baked in

I mean, what out of Europe could rattle us after Cyprus? And if the debt ceiling debacle in 2011 and the fiscal cliff in 2012 didn’t sink American consumers or derail the economy, what do we have to be afraid of?

Housing recovery

RealtyTrac reported yet another big drop in distressed property recently, with foreclosures hitting a six-year low. Meanwhile prices are up at the fastest pace since 2006, according to Case-Shiller. This housing recovery isn’t just good for jobs or homebuilder stocks and for lenders in the financial sector, but for the wealth affect it brings to consumers, too.

The Federal Reserve

Rates remain low, fostering investment and spending. Like it or lump it, it doesn’t appear that will change anytime this year — even if recent reports from Fed watcher Jon Hilsenrath make it clear quantitative easing won’t last forever. And if you’re a macro bear that expects GDP or unemployment to worsen, there’s even less of a chance Ben Bernanke will take his foot off the gas.

American resilience

One of the best lines I read last week was from Cullen Roche over at Pragmatic Capitalism, who wrote, “The Neanderthal who shorted Cro-magnon Man stock 30,000 years ago is sitting on hefty losses.” This reminds me of Warren Buffett’s crisis-era wisdom that “It’s never paid to bet against America.” Entrepreneurs and businesses always surprise us and the economy always has a second act — it always has. Besides, if you believe that humans are a doomed race and that America will become a Third World country… well, you have bigger problems then rebalancing your IRA based on that outlook, don’t you?

I’d also insist that the healthy skepticism will keep the rally honest, not invalidate the gains that have been made...I, too, have serious concerns about a slowdown in China or the damaging impact of a push for austerity in government when we need it least or the fact that many blue chips continue to struggle with their top line even if cost-cutting or mergers can goose corporate profits in the near-term. But the fact that investors continue to acknowledge these problems and debate them shows this is part of the current market dynamics.

A bigger question than why stocks have rallied, however, is why so many people distrust the run even though it is taking place right before their eyes. Here are a few culprits that I think are making Americans see what they want to see — namely, a market and perhaps even an economy on the brink.

Many left out

For many folks, they can’t correlate a stock market rally with personal success. Consider that Edward Wolff, an NYU economist, found that the average wealth of those younger than 35 tallied just $48,400 in 2010 — roughly half the $95,500 it was in 2007. Also, consider a 2010 Fed survey of consumer finances that showed 51.77% of families in the 40 to 59.9 percentile of household income — the very middle of the spectrum — owned stock in 2010, with a median portfolio value of $12,000. Meanwhile families in the 90 to 100th percentile of income owned stock in 90.6% of cases with a median value of $267,500. Clearly the young and the middle class have reasons to be skeptical that things are better, based on this data.

Market mistrust

From flash crashes to high-frequency trading to investment banking scandals, it’s easy to see why folks don’t trust the rally — because they don’t trust many things about Wall Street right now.

Bubble brain

Anyone investor who has been in the game for 15 years or more is painfully aware of the havoc caused by asset bubbles, whether it be the dot-com crash or the housing bust. That colors most investors’ attitudes. Scientists who have studied loss aversion have proven repeatedly that our losses hurt significantly more than our gains, so it’s no wonder traders are more preoccupied with the risk of a crash than the boon of continued gains.

Financial media

Yes, yours truly is to blame, too. The reality is that the two most powerful ways to get clicks are extreme fear and extreme greed. So expect the “fear” button to get pushed some more, even as the markets move higher. Keep these items in mind before you discount the data or let your doubts get the upper hand. It’s not easy to cut through the perception problems. I am self-aware enough to admit bulls can see what they want to see just as bears can. Market timing errors work both ways, and just like bears refused to buy low, the bulls may refuse to sell high before things roll back. But in the cold light of day, the economic data isn’t all that bad, and there remains a powerful push from the Fed to keep things moving in the right direction. You can’t fight the tape. I’ll remain fully invested (in funds — I don’t own stocks anymore to avoid the appearance of impropriety in my commentary) unless some big-time event changes the narrative. Because the current narrative of an iffy but ever-higher market is one that is just fine by me.

WOW! DELUSION?