That Ol' Black Magic

A correspondent on a financial blog this morning wrote,

“Last Friday’s equity market trading reminded us of this old Wall Street saying, 'The market bottom is defined when it stops going down on bad news.'”

Hmmm... the old Wall Street saying I remember is,

"The market bottom is defined when it fails to rally on good news."

The logic is that when even good news can't raise buying interest, we have exhaustion which confirms the capitulation. There is a wide-spread misconception about the meaning of capitulation. Many people and pundits think it is when we have a large downdraft in stocks, and indexes find new lows.

That is a necessary occurrence, but not a sufficient one for a complete capitulation.

From Merriam-Webster's Online Dictionary:

ca·pit·u·la·tion: The act of surrendering.

Capitulation occurs during and after the downdraft, when the majority of market participants just throw up their hands in dismay, throw in the towel, and say, "I'm done!" After capitulation, the market languishes and even good news can't make it smile.

Yes, stocks are rising and all looks rosy. But don’t be deceived. A major missing ingredient in today’s rally is the “wall of worry.” Until we have a real capitulation, until we truly have exhaustion, and until we start climbing that wall, this rally is not only suspect, but can be considered malevolent. It will end badly.

The current generation of investors has been conditioned, thanks in large part to the Internet, (and also to a pervasive herd-mentality of short-term thinking) to believe that things always happen in Internet time, and that events have the longevity of a sound-bite. "OK, the market has bottomed, we can check that off the list. Now we will rally."

The "real world," however, (as opposed to the virtual world that has become the new shibboleth) does not operate like that. We are currently in a bear-market rally, and we have not yet seen the capitulation. Those who feel strongly that we have, will soon be parted from their money.

The economy is getting palpably worse every day, every hour! Do you really think that the companies you are investing in are going to prosper near term? Massive layoffs have been announced and more will come soon. Retail is in the doldrums. Manufacturing has all but ground to a halt. International trade simply is not happening. Foreclosures are causing even safe and sane mortgage borrowers to be upside-down in their homes.

All of the recessions and downturns in recent memory have been "bailed out" by consumer spending. Today’s' circumstances are far worse than any of those others until you go back to the Great Depression. The outcome to this recession will be much worse and it will last much longer because (I hate to break it to you, but...) the mythical consumer will not be carrying the economy on his back this time.

Too many consumers have lost, and will lose, their jobs. Too many consumers are already mired in debt while consumer credit is drying up. Too many consumers have witnessed a major loss in their retirement portfolio. Too many consumers have seen their home equity evaporate.

A report on NPR this morning detailed the problems that a large wholesale clothing distributor in NY is having. They have a warehouse crammed full of top line suits, shirts, slacks, and other apparel that they can't move. They normally supply major retailers with this merchandise, but within the last three weeks, four of their seven largest customers have cancelled all orders for the next season.

Do you really think that we can spend our way to prosperity this time? What fairy tale events are going to magically produce profits for companies that are retrenching and not conducting business?

He that lives upon hope will die fasting. -- Benjamin Franklin