The markets are off today with flying colors, a somewhat expected result from a bounce-back from Tuesday's sudden decline. As I write this, the Dow Jones Industrial Average is up 140 points, which if the markets were to close right now, this would result in a mid-week performance that has ended at parity with Monday's opener. In other words, after 3 days of back-and-forth trading, the major indices have netted exactly 0%.
Unlike other financial analysts, I don't see stalemate as a unique category. In the markets, if you are not moving, you are dying. The one truism that applies to both bulls and bears is that movement is necessary for their survival : nothing meets universal contempt than a sideways trending market.
Of course, it is better (as a long-term bull) to be stuck in consolidation rather than to witness a sizable drop in valuation, but consider this : in a massively traded equity market like that of the U.S., stativity is not an indefinite circumstance. Either people will see value (either present-value or perceived future-value) or they will not. The latter decision will almost surely result in a substantial correction.
But is there a case for the former argument? Can a reasonable assumption be made that people see value in the domestic equities sector? I find that though the present value of the overall markets are not over-priced based on a traditional methodology such as the P/E ratio, the ability to wage competitive battle for our leading companies have waned.
A recent solution for the economic recession brought forth by Dr. Amir Sufi, a professor of finance at the University of Chicago Booth School of Business, is perhaps most telling. Dr. Sufi's research finds that in times of great economic turmoil, societies have adopted a form of "debt forgiveness" for its populace that were forced under by circumstances outside of their control. Implicit in his argument is that the U.S. government failed to provide such protection for its constituents, but instead, awarded it to the banking and financial conglomerates most responsible for our present crisis in the form of bail-outs. Dr. Sufi goes on to state further that by saving large institutions and not the middle-class worker, consumption as an aggregate total has deteriorated.
What is apparent in the stock market today is that the large-cap companies are doing just fine, thank you very much! However, the base upon which these companies sell their wares to have practically declined, though not in number. This creates a watered-down effect where foot-traffic and revenue may go up, but profitability may go down. But according to historical data, revenue is going down while earnings (net income) are beating expectations.
How is this possible? Before a company reports net income, they must filter through several layers of revenue streams, costs, and expenditures. Amongst the favorite of large companies is cost-reduction, ie. layoffs, ie. store closures, ie. "bottom-line thinking." This reduces costs and top-line sales but it increases profitability (when done correctly).
While Wall Street encourages the practice, companies that engage in such low-level strategies are acquiescing to defeat by permanently curtailing its forward-basis potential. In human terms, it's a losers mentality and when you have a losers mentality, you typically lose.
This mentality is celebrated on one side of the books (the investment community) and that is why the practice continues. If we live in a disposable society, how much more so is the stock market? But eventually, the situation cannot indefinitely perpetuate itself. At some point, you're making money or you're not.
The domestic markets may be reaching that point. I could be wrong but the warnings are readily apparent. And I'm just not ready to take that risk...