It is always interesting to question any conventional wisdom in the stock market, either when the mood is overtly pessimistic or optimistic. A lot of market watchers would point to a time-honored maxim that the market is at all times right.
As a general rule, this approach would be correct; one has to presume that the market is usually right.
On the other hand, all rules have its exceptions and this is one good example when markets are less than correct. This is due to current wisdom that since the economy of the US is moving towards recovery, the outlook has to be rosy and so stocks are cheap. There is also this mantra from investment banks and broking community that markets have more upside; more earnings upgrades to bank on and the direction for economic growth is heading only upward.
However, one could ask, why there is still such widespread skepticism among market observers? Ernest Kepper, a financial consultant described recovery as ‘phony’ in BT’s Aug 20 Roundtable.
All these concerns may be dismissed as simple, mislaid over-conservatism is stock prices are truly cheap relative to future prospects. However, there are lots to ponder here.
In worse scenario, the present dividend yield has slipped 2 percent while the trailing price/earnings soared 24 percent, suggesting that “the marginal buyer of equities today may well be the same person who was loading up on real estate during the summer of 2006”.
Thus far, the latest figures showed that the decline in US consumption is leveling off, but this was most probably attributed to tax cuts and the stimulus taking effect, both of which can only offer temporary relief. With only 0.2 percent growth in private sector wage and no real improvement in employment, it is not likely that US consumers can perform their role to take the economy out of trouble in the coming months.
As some critics have correctly pointed out, more damage that good may be produced by stimulus packages as they hamper economies to heal themselves and delay the inevitable downturn.
Therefore, where does this leave the investor who is considering where equities may be headed in the coming months? First, it is best to recognize that a part of Wall Street’s rally since March was fuelled by liquidity, perhaps even driven by funds from US bailout packages that was silently directed to investment banks. Liquidity dries up along with the momentum.
Second, government stimulus and spending can help ease some of the pains of time especially when both are financed by government borrowing. This is for the reason that artificial development of the sort being engineered in the US arrives at a price, and this could take the form of higher taxes and higher inflation, as many have predicted.
Third and maybe the most significant though, is not to get too carried away by the announcements from the broking community that the grim is over and that it is all happy days ahead since there is more rooms for skepticism.
Put differently, it is best not to rely too much in the dictum that the market is constantly right as there are times that is not.