By Jacob Hess
Metaphors, in my opinion, can add a lot to the ideas surrounding the stock market and its movements. Often times, they can paint pictures more insightful than those of simple numbers, but at the same time, their themes may be over or understated. For that reason, history sees a lot of finance commentators burned on their choice of words. None was put under more scrutiny than Ben Bernanke as the Fed chairman during the financial crisis of 2008 where debates over one word were not uncommon. So I will attempt to take on the same responsibility as I use the images that I think of to describe my ideas about current market conditions. Over the past three trading sessions, we’ve seen pared losses looking to cap out market gains. No major losses plague any security except for extenuating circumstances. I liken it to a glass of water that’s been filled to the brim. When it reaches its inevitable point of full capacity, the drinker ofter takes a small sip to quell that chances of overflowing. That sip takes not much more than a tiny amount off the top and does little to quench the thirst of our drinker. After a few moments now wanting more water, our drinker will reach for another larger glass, move the water into the new glass, and continue to fill until full once again. Many analysts have brought into question the momentum behind the rally, but positive earnings surprises in the tech sector and elsewhere have helped maintain demand in the system. Investors continue their thirst for equities and do not see the prices as an overvaluation except for a small crowd of bulls that snubs the rallies most of the time. Most of the gains, though seem very expensive as a strong dollar and low inflation keep them costly to foreign investors. The commodities market, as well, has experienced a relatively bullish recovery in the latter part of this year despite trade deficits hurting emerging markets revenue streams, and in turn, damaging prospects for demand growth in the future.
Here, the chart shows the stabilization of the GSCI Emerging Markets index after the bullish October. Although losing girth just before November on high volume, retracements of almost 100% followed shortly. For now, it appears trading is stuck in a price channel with hopes of it developing to a continuation pattern and doubling gains. Moving closely with it is the basket index of commodities, CRB Reuters-Jefferies Index, charted in black. They seem to move really close to each other until October when emerging markets outperform the basket. In my opinion, the underperformance of commodities in relation to emerging markets is what’s hurting the chances for a rally for EEM. Energy prices and most other industrial commodities are hindering inflation which can be healthy for developing countries looking to buy into foreign economies as well as trading with them. Today, the chief economist of the IMF has touted the potential pain of stagflation growth in advanced economies. Referring to data put out by IMF, he cites current inflation as at the same levels of 2009, when a post-crisis recession spurred unemployment to 10% in the United States. Inflation has slowed from its 2.7% peak in 2011 to 0.3% that is predicted for the end of the year (2009 inflation was 0.2%). Worried politicians voice their concerns for stagnant wage growth even though unemployment levels are basically at full capacity (U.S. jobs report to come out tomorrow). Frustrated central bankers and state economists have no choice but to point to controversial monetary solutions like open market operations and quantitative easing. As the Fed continues to evaluate growth for December rate raises, flat movement at market highs populate sessions between the two meetings. The S&P 500 and Dow Jones Industrials pare losses to -0.35% and -0.28% for the day. The Euro STOXX 50 and England’s FTSE 100 move blandly at -0.10% and 0.46% over the day as well. Most emerging markets’ indexes gain and lose under 1% as whipsaw movement often ruptures accumulated gains or losses over a small amount of time: India loses -0.27%, Brazil loses -0.80%, and Turkey gains 0.83% after a day. Many foreign economists and investors are waiting for the Fed’s decision on interest rates in December, now rated at a 60% probability, to see where emerging market sentiment will go.
There are two groups following different psychologies on the market today, and they are using the same information to prove their mindsets. The bulls are trading openly and according to earnings that have come out. They believe that their demand for securities is matched by their counterparts and aren’t afraid to commit their capital to an open market that appears less scary after seven years of recovery. The August correction, to them, is a reality but one independent of the prices and valuations that they trade on now. Emerging markets are recovering to them, and the Fed’s willingness to raise rates is a signal of strength. Most of the bulls don’t focus on inflation statistics but support their sentiment with data behind a strong job market. These traders are focused on sectors like technology, healthcare, and construction which have posted high 1-year gains despite a major contraction in August. Construction and homebuilders point to a recovery in the housing market with home sales and home starts increase from a stronger dollar making imports cheaper. The bears retain a scrutinous mentality when trading in the current bullish trend as they see gains as unsustainable pointing to losses in August after a correction shed value that was previously at this level. Some bears might even be skeptical of a market just seven years out of the worst financial crisis since the Great Depression. They might blame a long period of low interest rates for an over exhaustion of cheap funding and the dismantling of profits in the bond market. While they see interest rates as good, they would predict major contractions like those in August after tighter monetary policy hurts commodities and emerging markets. These bears are the short sellers keeping the bulls at bay, and there seems to be slightly more pressure from them on days that are uneventful. Bearish sentiment has the power of uncertainty on their side, but that doesn’t mean more volatility. The measure of volatility index, VIX, has been at its lowest levels for the entire year which fuels confidence. Nevertheless, bears cite deflation risks and the problem of depreciation in commodity prices as endangering cash flow levels. For that reason, bears exist in industries related to commodities like metals, energy, and consumer goods. Even though they lead gains in October, bears believe a reversal in these sectors could lead future losses. They also see revenue and corporate income dropping as funding gets more expensive. It is important to recognize the psychological bearings behind sellers and buyers. Depending on volume and movement when trading is mostly uneventful, investors can determine which market outlook is being supported more. Trading is just making predictions and sharing opinions, and volume is the strength of that opinion. That being said, group psychology can often lead to incorrect assumptions just like 2001 and 2008. Going forward, I’ll make sure to address the validity of each market psychology as the market goes forward.