Tuesday, September 21, 2010

The Stock Market As A Voting Machine

I am not sure I would ascribe the market's recent frenzy of buying activity to anything more than short covering.  Yesterday's "breakout" seem to get the bulls all lathered up, but when I hear the words "breakout" it is like fingernails on a chalkboard.  There is little significance to a "breakout" and context (i.e., bull market v. bear market) really does matter. 

Nonetheless, investors and commentators want to find significance in the price action.  According to the bulls, the relentless upward thrust of the past 3 weeks can only mean one thing: the economy is getting better.  From this perspective, it doesn't seem intuitive that a $14 trillion economy can turn around like a speed boat; I would expect something like a cruise ship.  Furthermore, the perception persists that the stock market leads the economy.  In other words, the price action validates the economy, and it is rare these days to hear someone have conviction on the economy and not point to the stock market.

Another example of the "stock market as a voting machine" phenomenon can be heard in the analysis of yesterday's town hall meeting with President Obama.  The meeting was declared a success because the stock market didn't sell off - it didn't gain either - while the President was on TV.  Of course, the content of the President's words or rhetoric is irrelevant, and the only thing that matters (i.e., acceptable to Wall Street) is that the market didn't sell off.  Therefore, it must be good policy.

In reality, such simplistic views prevent serious discourse on important policy, and clearly create a "we must do something now" mentality.  All of this smacks of the Afghan/ Iraqi conflict and the Wall Street bailouts.  Do something or the world as we know it will come to an end.

When stepping back and looking at the markets objectively, it seems silly, but unfortunately, this is the market environment we are in.  My view is that the market is very overbought and sentiment has turned bullish very quickly.  Anecdotally, this "rush to judgment" - as in you got to be on board right now- is more consistent with a market top than a launch of new bull run.  This remains a range bound market at best, and I would expect it to be so at this point in the price cycle.  The market is likely to be ruled by the overbought and oversold oscillators, and typically, it takes awhile for the overbought side to kick in.  Over the next couple of weeks, there will be a discourse regarding the significance of the recent market action.  That is what a short term market top is all about. 

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