Where’s the Good News?

It’s hard to be a stock market bear these days. With the S&P 500 up over 45% since its March lows, I suspect that anyone who has been telling you to sell stocks and hold cash (or gold) is feeling a bit sheepish right now. And yet, many of them are still out there pounding away on the Big Bear Story – the economy has massive structural imbalances, U.S. consumers still have heavy debt loads, the housing market is on life support, toxic assets still abound on bank balance sheets, massive commercial real estate write-offs are coming, people are still losing their jobs, etc. And if that isn’t enough to scare you into selling stocks (or not buying them again), they can dust off the nasty, old hyper-inflation specter (absent seen since the 1970s) and try to convince you that if the recession doesn’t get you, then the massive inflation coming down the road will.

The casual observer may wonder why the stock market has appreciated when all around us we only see bad (at least at face value) news. Take the latest employment report for example. At face value, the report shows that 247,000 people lost their jobs in July. How in the world could that be good news for the stock market? Well, you see, the stock market always cares about data (government releases, corporate earnings, etc.) relative to expectations. The market had been expecting a July job loss of 275,000; by the perverse calculus of the equity market, the July employment report was deemed “good” news.

This idea of the market responding to numbers versus expectations is a key factor as to why the market is up so much since March. At some point earlier this year, the numbers ceased to worsen at an accelerating rate. The numbers (economic data, earnings, etc.) were still bad, but were not getting much worse. Later, the “badness” of the numbers started to improve. About now, the numbers are getting “less bad” at an accelerating pace. For all the talk of the need for structural change in the U.S. economy, the pattern of how the stock market interprets and responds to new information is classically typical. In other words, the stock market since March has responded in an absolutely normal and rational fashion to the new data it has been shown.

Alas, dissecting the past is always easier than predicting the future. I never make predictions (“official” ones anyway), but I do watch those who get paid to do it for a living. Last week the percentage of equity strategists who are bearish declined to be roughly equal in number to those who are bullish. For months, bearish strategists vastly outnumbered the brave, but clearly contrarian, bullish ones by a large margin. To me, this strategist parity suggests that the market can continue to rise. As things continue to get “less bad” and when we eventually begin seeing legitimate “good” news (like the third quarter U.S. GDP figure, which is likely to be positive, from what credible economists are saying), I suspect more of the bearish strategists will change their minds.

This week Abby Joseph Cohen, Goldman Sachs’ equity market strategist, stated that she believes a new bull market has begun and that the S&P 500 could close the year somewhere in the 1,050 to 1,100 range. The first rule of being a Wall Street equity market strategist (I used to be one) is to never make a prediction which features both an exact time and market level. This is why you hear things like, “I think the market will eventually reach the 1,200 level” or “I think the market can be higher by year end,” but rarely, “I think the market will reach 1,200 by year end.” Abby Joseph Cohen, being the seasoned strategist she is, finesses this by providing a range for her year-end forecast. Anyway, I think her comments are significant because I think this is the first time a high-profile strategist has come out and said that the bear market is over.

I tend to agree with her, and given the large amount of skepticism out there, the huge mountain of cash still on the sidelines and the massive amount of pain investors experienced during the bear market (hence their reluctance to jump right back in), I can see the market continuing to climb this wall of worry.