Tuesday, April 16, 2013

We're Dancing - Until the Music Stops

We can dance if we want to
We can leave your friends behind
Cause your friends don't dance
And if they don't dance
Well they're no friends of mine

There have been several recent articles complaining that the economy is not “in sync” with the stock market.  Of course these articles are rubbish and not worth even skimming.

The economy and the stock market are like a pair of flamenco dancers.  The man (the economy) usually takes the lead and the woman (the stock market) usually follows. But the woman can also lead, as the man watches admiringly.  At times (let’s say when the economy is very strong or very weak) the man and woman dance very close and in unison.  However there are many times when the dancers are physically distant and even though they share the same floor and music, the dances are not the same.

Let’s pretend our flamenco dancers were performing on a ship that encountered some horrific waves (the Great Recession).  The man was thrown off the floor to the right and injured his leg.  The woman was thrown off the floor to the left and broke a heel.  While the music continued to play, the man struggled to regain his bearings and limped back to the dance floor.  As he did, the woman repaired her shoe and still dazed, tried to resume the dance.  This dance is not going to appear very graceful for a long time.

I have written before about how many reliable economic indicators are still out of sync. So why would you would expect the economy and stock market to be more coordinated now? 

Yes, in the long run and in the big picture, the two have to be well connected, but at many times the correlation suffers.  If it didn’t, it would be much easier to predict the stock market.   The economy is basically the economy, but there is a big emotional and psychological aspect to the stock market.  Sometimes she dances as expected and other times she has a mind of her own.  But she is so sexy when she dances, that investors cannot resist her.  She creates such passion in her followers.  She rises, she swoons, she is memorizing.

The other strange thing about the articles is that you could argue the economy and stock market were actually dancing close together in Q1.   The economy grew 2.7 percentage points more than the previous quarter. (3.1% estimate Q1 minus 0.4% in Q4) and the stock market was on fire.  Of course the problem with this is Q1 is still just at 3.1% GDP and this is expected to be the strongest quarter of the year. 

And the employment report for March was just dog awful.  When almost a half million people are so discouraged they quit even looking for work, your job market reeks.  I’m so glad our government is laser focused on the economy and job market instead of spending time working on peripheral issues.

The latest Wall Street Journal Economists Survey GDP (total survey average):

Q1 = 3.1%
Q2 = 1.8%
Q3 = 2.4%
Q4 = 2.7%

If you would forecast the stock market from this data, the market would continue to increase at a slow to moderate rate the rest of the year.  However, virtually no one is predicting this scenario.  The two most common forecasts fall in one of two categories:

1.     The market is way undervalued.  The market will continue to go up, up, up, in anticipation of the economy growing even stronger.  Some proponents of this theory predict the market is about to explode into the stratosphere.

2.    The market is way overvalued.  The stocks have risen in anticipation of a stronger economy which hasn’t materialized.  Banks are weak, Europe’s weak and Obamacare is going to kill the recovery.  Some people on this side are not predicting a correction but a huge crash.

So that makes it very clear what to do, right?

Model T Update

The Model T prediction of an S&P peak of 1550 was surpassed on March 11 when it closed at 1556.  The plus 2% upper limit of 1583 was breached with a 1587 close on April 10.   This means the Model T was not able to predict the market peak within a 2% range this year. It does seem like the market is currently bouncing around in this range, which would indicate that we are near the top.

However the value of the market peak is not as important as the timing of this peak, and the Model T is still predicting a peak in the May/June period.  If the market is peaking in May, you would expect it to be humming in April.  I didn’t explicitly state this in my January (Sell your Stocks in May?) post , but of course it was implied. If you are not selling until May, you still expect to be making money in April!

Next Post: It’s Put Up Or Shut Up Time!

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