continuing: how to read and ride the wild market
To better understand the dynamics of the economic momentum, you may envisage the motion of a cruise ship (not speed boats).
If you have been on a cruise or watched the movie, Titanic before, you will probably notice that a ship does not speed off like the swift acceleration of a car. The heavy load seems rooted to the seabed at the initial acceleration [US700 billion Stimulus package] despite the loud roar [media focus] of the turbines and only begins to inch forward after a while [recovery]. Once the ferry gets on its forward momentum [GDP growth sustained], the cruise becomes smoother and less jerky [expanding]. Along the journey, momentarily, the built up velocity is often interrupted by the waves generated by passing-by vessels or ships [confusing indicators] before it eventually reaches full velocity [high GDP growth] in the open sea [global market]. In the open sea, the crew [economists and advisors] checks on the engine [state of health] and make sure it doesn’t overheat [inflation]. When there are any signs of potential damage [inflation], the crew repairs [adjust fiscal and monetary policies] to keep it going smooth [low inflation and GDP growth]. As the ferry is about reaching its destination [high inflation], you will hear the roaring [ warning of inflation] of the turbines again as the captain [Ben Bernanke or FED] starts to decelerate [interest rate hikes] early so that there is enough stopping distance from the dock [soft-landing]. If you were on board, you would feel the weight [products and services] of the ferry pushing against the ‘braking’ force [lower money supply] of turbines under your feet as it [demand and spending] starts to retard on the waters [economy]. The turbines [ fiscal and monetary policies] have to be thrust at high speed in reverse many times [several consecutive interest rate hikes and tax implementation] just to get the heavy metal [consumer confidence; borrowing and spending] to succumb to a complete stop [deflation]. The dynamics of economy is very similar to the description of the cruising ferry. When an economy gets on track and gain momentum, whether on contraction or expansion (i.e. recession or growth), it will continues to stay on course until and unless something substantial [Subprime Mortgage Crisis] enough happens to force it to change its course. Even so, it takes a while before a new phase takes over; you can imagine a ferry making a U-turn on this. And in the movie, when Titanic hit the iceberg, the ship did not sink like a stone thrown at the water. It took several hours before it got into the vertical position and broke into halves. That was the moment when the ship sank really fast. The Subprime was quite the same when it happened. It hit the market sometime in October 2007, but the market managed to hold against a nosedive and only ‘sank’ a little for months until one year later in October 2008 when the subject could no longer be contained as the market finally realised the magnitude of damage when the issue was brought to the debate of the proposition of an infusion of US700 billion Stimulus Package to save the economy from collapsing. Now, as they observe signs of recovery, they are ‘telling’ the public that they might remove some stimulus measures; to keep the inflation out.”
“Oh, so that's the business of governments; managing the economies. What about the common sense you were saying?”
“As you can see by now, this vision of the economic outlook as a signpost that surround the general but vital concern of the future earnings performance of all the companies within the framework of the economy offers the big players a ‘big picture’ that suffice them to boldly and confidently buy into the market in waves because they know how the economy, the companies and the stock market are all in the same boat. They know that once an economy is on track, it will go on for at least a few good years, not only because history says it but because common sense tells them that it's the interest of all governments to keep their economies growing steadily for as long as they can keep inflation away. Those politicians should be more concerned about the survival of its economy than anyone else because that’s the only sure way to win an election and that also means someone is taking ‘extreme’ care of the part on making sure the businesses thrive. Just recall how the respective governments had responded to the recent Subprime Crisis and you will know what we’re saying. In fact, you’ll find that economic growths in the more developed nations are so compulsive and prevalent in nature that their Central Banks are more concerned with inflation than recession. And therefore, when one understands this economic nature, a vision is no longer a vision but an assurance; it becomes something that they can almost take for granted and use it to ride the market with unwavering confidence. All they need to do is to select the best of the companies that will be able to reap the most of the opportunities an expanding economy brings about and leave the ‘job’ of creating opportunities to the governments.”
There was silence and Rex was giving all his attention as we continued to explain, “This vision can be ahead of the actual economy performance by six to nine months and held for as long as three to five years. In other words, the big players would take the risks to buy into the market by taking a bet six to nine months ahead of the future of the economy and they will hold their positions for years up to five. They don't read the stock market, but the economy. And they will buy all the way until they get their ‘maximum’ exposure. This buying often is aggressive, especially at the early stage of their buying ‘mission’ and it signals to the rest of the market to follow. When that happens, prices jump and the whole market goes into a rally that often send stock valuations overshooting to the red zone. It becomes overpriced. And that’s when the market is ‘reminded’ by the analysts. Then we get a price correction to a more reasonable but still way ahead of the actual performance price level. The market stops but refuses to move down much all despite ‘uncertainties’ and confusing indicators because the big guys know it's a matter of time the actual results will catch up and so it will keep maintaining the price premium because that’s the risk/return component the big players demand for their bold moves in taking the stocks before anything becomes obvious of a recovering or booming economy and their better understanding of the dynamics of economic function. The market starts to move again after the correction and again in tandem with the future of economy.”
“So, a trend is the long term direction of the stock market, and this long term trend blossoms and withers in tandem with the two phenomena of the economy; expansionary and contractionary phase. In between the trend line, you get these ‘uncertainties’ that cause waves on the trendlines that go zig and zag all the time; the one that gives me all the headaches and sleepless nights?”
“Sure as fish is fish. If you are able to appreciate our opinion about the stability and predictability of economic trends, and the fact that the profitability or earnings performance of businesses very much depends on state of economic conditions, you can then almost confidently conjecture where the stock market is heading by taking a view on the state of economy. This first part of the knowledge shows you the big picture, the big trend to be precise with words. It is helpful in that you can now ignore the corrections that inevitably come along with every price spike or rally. In fact, you will now see a correction or dip as an opportunity to buy or accumulate on good shares and not panic into selling or short-selling against a trend setting which is hideously guided by the underlying fundamentals of the economy.
...to be continued
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