Before today nobody expected anything less than a horrific second quarter earnings season. As well, no one expected that the labor market did not continue to weaken in June. However, after a series of warnings from tech companies, and a non-farm payrolls number arriving at triple the estimates, investors seemed surprised. The markets dropped.
In truth, the markets may have dropped this week simply because there was not enough brave capital left to allow speculation to go unfettered. The current speculation is that economic earnings will begin to improve in the latter half of 2001. Moreover, it is widely believed that the economy will avoid recession and ride off into the sunset without breaking the consumers back. But what this speculation eventually needs is some hard evidence. To date there has been little.
The sell-off this week was embellished by the fact that mutual funds used up capital to dress up portfolios prior to the quarters close (June 30). As well, a mid-week holiday hurt volume trends, and the arrival of the summer trading season continues to numb overall enthusiasm. However, what this slide does not translate into was anything of the realm of spectacular. With the Nasdaq holding onto the psychologically important 2,000 level, and the Dow still well above its former nemesis (10,000), investors can walk into the weekend knowing it could have been worse…
The Dow lost 227 points with NYSE surpassing 1 billion shares traded, and the Nasdaq slipped by 75 on a soft 1.45 billion. Decliners doubled advancing issues on the NYSE, and breadth was 25-11 negative on the Nasdaq. The VIX shot as high as 26.26 before settling below 25.
A stronger than expected June NAPM index was one of the three leading indicators arriving early last week that initially helped the markets. The others being better than expected construction numbers, and factory orders – both out for the month of June. But what these, or any other indicators, cannot do is accurately describe the overall economy. In fact, when looking at how strong the housing market has been this year the argument could be made that certain economic readings can ignore the larger economic picture completely. What, if anything, does describe the economic environment going forward?
Are The Stock Markets A Leading Indicator?
Let me be the first to tell you that investors (meaning the markets) do not have a clue. To claim that 50% of the U.S. population understands the relationship between stock prices and the underlying corporations is not only naïve, it is deplorable. Most investors today do not even invest their own monies in the markets – they allow a manager to do it for them. Furthermore, most investors today do not attend shareholder meetings, read or fully understand prospectus's (from the SEC) and/or grasp the basic terminology associated to trading mechanisms, and financial statements. To be sure, most investors today do not invest at all - but here is the kicker - they still have money in the 'markets'. As such, you cannot claim that the markets are an object that comment on the future direction of the economy: we do not have any method of knowing what millions of American's are thinking when it comes to their equity positions.
A stock market decline does not tells us that the worst is not yet over for the economy, just as a stock market rally since April did not tell us that the economy will avoid a recession. In sum, the stock markets are not a reliable leading indicator. What is a leading indicator is what Betty Jones from Nebraska will do with here portfolio tomorrow. Will she shift her equity position into bonds to avoid risk? Will she buy money market funds and await a 'new bottom' in stocks? Will she sell out completely and open a savings account after she gets laid off? I do not know what Betty and others like her will do with their money tomorrow, and Betty probably doesn't know either. All we do know is that the markets dropped today, and recently many people like Betty where brave enough to 'invest' for the late 2001 recovery.