shifting from down market to up …and vice versa

the traditional market

Historically, the US stock market has been the best leading indicator of the the US economy, signally both expansions and contractions by about six months in advance of their appearance in official government data. I don’t think there’s a generally accepted rationale behind this phenomenon.

The explanation I’ve arrived at over the years is that if you work inside any corporation, particularly an economically sensitive one, the in-house grapevine is an exceptionally accurate way to get a feel for how business is doing. Things like: …no raises, no bonuses this year …the food in the cafeteria is worse than usual …cutbacks on business travel …layoffs are on the way or …bonuses will be really good …personnel is paying $1000 for hiring recommendations that pan out …the company picnic is back, and it’s in a hotel, not the conference room.

Retail companies like Walmart or Target are also treasure troves of information. Are customers buying low-end $10 jeans, mid-range $20 jeans or money-to-burn, brand-name $40 denim? Manufacturers’ order books are information gold, as well.

Whatever the transmission mechanism, it’s important for us as investors to realize that anecdotal evidence of the economic gears changing is in the air long before there’s official evidence either from corporate results being announced or data being collected and summarized by Washington.

(Note: two opposing forces have affected the lead time between stock market and economy. On one hand, the speed of information flows continues to rise at a rapid rate. On the other, during my working career, armies of very highly-paid securities analysts vied with one another to find, and act on, key data ahead of the pack. Not only that, their years of experience covering a given set of companies allowed them to appreciate the significance of new data a lot faster than neophytes. Virtually every one of these living libraries was laid off, however, during the financial crisis of 2008-09. More on this–and what I perceive as the new way later.)

So the real question behind why the stock market leads the economy, I think, is what makes investors shift from playing defense to playing offense and vice versa.

the shift is a judgment call

My observation of professional investors is that, even though the best continually reinvent themselves as they adjust to economic change and development, no one I’ve ever been aware of has been able to call both market tops and market bottoms. Myself, all of the performance evidence is that I’m much better at up markets than down and that I can call bottoms much better than tops. This last is what I want to write about.

From the market high in mid-November 2021 through last Friday, the S&P 500 has fallen by 11.2%, NASDAQ by 20.0% and ARKK by a mind-boggling 53.8%.

My checklist:

  1. Has the market fallen enough, i.e., are valuations reasonable or better, given expected profit growth and interest rates?
  2. Are any big new economic negatives looming or have the final shoes already dropped?
  3. Are there any signs that value-style investors are picking through the rubble of the worst-hit sectors/stocks?
  4. Has there been a cathartic event, a panic-driven selloff where holders sell without regard to price? Two indicators of this: very high volume, unusually sharp price declines, all coming after months of uncertainty.

more tomorrow

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