Stocks: Detached from Reality

The stock market has abandoned rationality. Sure, it usually rallies ahead of evidence of measurable progress in the economy, but the rally from March to May had already priced in a strong ‘V-shaped’ recovery, which will, obviously, not happen. At best, we’re in for years of stagnation and lower living standards as society inflates away, pays down or writes off bad debts.

The recent rally, starting on July 13, has raised the bar for corporate earnings over the next few quarters even higher, setting market participants up for another round of disappointment.

In the financial, REIT and consumer discretionary sectors, the market completely detached from reality. Part of this can be explained by the growth of program trading based on backward-looking statistical inputs, part by the triumph of technical analysis over critical analysis, and part by the herd behavior of fund managers.

Regarding the triumph of technical analysis over critical analysis, ridiculous notions like the following are clearly driving the market higher: “We just broke through ‘resistance’ at 950 on the S&P 500, so therefore, it’s a mathematical certainty that we’ll go to 1,050 or 1,100.” This kind of ‘analysis’ is dangerous. When we all start watching and reacting to charts and stop thinking critically about what stocks are intrinsically worth based on reasonable assumptions about the future, the adjustment process back to reality can be violent and painful. The 1987 crash is a case in point.