The Cognitive Dissonance Market

July 22, 2014

Investors’ Staggering Indifference Amid Rising Dangers

As a 25-year financial industry veteran with a broad background in managed money, market history, and risk mitigation, I have become amused—shocked really—at the cognitive dissonance being displayed by some in the investing public in this 6th year of the Federal Reserve’s “Recovery Market.”  Not since early 2000 during the heady days of a peaking tech/dot-com market, have I seen such displays of indifference, sans the enthusiasm of that euphoric run-up, for the market’s 183% advance of the last 64 months.  In essence, investors have become divided into two groups; an older, 65-80, never-trust-the-market-again crowd—and a slightly younger, 45-65 group of tightrope walkers with all too short a memory, motivated more by a desire not to miss out, than by a love of what the market is offering.  And while the market is offering one thing, the economy seems to be offering quite another, given the recent downward revision to first quarter GDP to -2.9%, a decline tellingly ominous when you consider that all previous contractions of the same or higher magnitude occurred during recessions 18 out of 18 times in the post-war era.

To listen to the talking heads on Wall Street, one might think that simply because we’ve finally recovered our index valuations from 2000 and 2007 (the NASDAQ is still 15% below its all-time high 14½ years later), that those two crashes, -51% and -57% respectively, never happened.  It’s as if we’re to believe we were dreaming when we twice lost half of the monies that it took some of us 40 years to save, encouraged to “stay the course”, i.e. remain risk-exposed, by a brokerage industry’s clichés of “long term investor” (at 65?) and the greed-inducing query, “You don’t want to miss out do you?”  Presumably it makes sense to some to ride a collapsing market all the way down, just so you can ride it tentatively, fretfully back up again—a bit like burning your new house down just so you can rebuild it.

One of the things that has amazed market watchers about this particular bull market is how truly unloved it has been.  Even as the indexes have reacquired new record highs this year, they have done so amid a staggering decline in trading volume.  Average daily trading volume, tallied by month, was down over 53%—just 5.8 billion shares in May, less than half of the peak of 12.3 billion shares achieved prior to the financial crisis.  “There seems to be no excitement in the market anymore,” says Peter Cardillo, chief market economist at Rockwell Global Capital.  He and others worry that lower trading volumes for U.S. stocks might indicate a disturbing lack of confidence in the market, even as stock prices march higher and the Dow Jones Industrial Average hovers near 17,000.

The growing list of geopolitical hotspots around the world is another potentially catastrophic area that investors are ignoring at their peril, according to most seasoned market watchers.  Like rodeo clowns dancing with a fearsome bull, many now believe investors have no concept of the danger they’re in, or of how easily things could turn ugly.  Conflicts between or within Syria, Israel (where 40% of their population is in bomb shelters), Iran, Egypt and now Jordan in the Middle East, are a continuous threat to oil price stability, and threaten to ensnare larger economies in Europe and Russia.  The announced failure of a key Portuguese bank to make its most recent interest payments to its creditors has reawakened Wall Street to the still-unsolved structural problems in Europe, even as German and French industrial production, along with investor confidence, seems to have hit a wall.  And last week’s shoot-down of a commercial airliner over Ukraine initially spooked the DJIA to the tune of 182 points, only to have it recover most of that last Friday.

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On our own shores, we are witnessing the slow, painful death of many retail bellwethers, from food service to clothing and apparel, to home improvement.  Wal-Mart profits plunged by $220 million in the first quarter as US store traffic declined by 1.4%.  Target profits dropped by $80 million, Sears lost $358 million and sales at Kmart plunged over 5%.  JC Penney, Kohl’s, Costco, and Staples also saw reduced profits, as the latter fell by 44% as sales collapsed and the office supply retailer announced the closing of hundreds of stores.  The Gap, Ann Taylor, American Eagle, Aeropostale, Big Lots, Best Buy, Macy’s, Dollar General, Urban Outfitters—even McDonalds saw earnings drop substantially.  If the market’s advance is supposed to be earnings based, someone has clearly forgotten to phone in these recession-like results.

In a famous Peanuts cartoon, Lucy begs Charlie Brown to take yet another run at the football she is place-holding, pledging not to pull the ball away but to allow him to kick it with all his might.  Like today’s investors, poor Chuck seems unable to learn from his own history, and lands flat on his back for the umpteenth time, lectured afterwards by Lucy as to how gullible he has been yet again.  As Galbraith said, “The extreme brevity of the financial memory” is eternally at work in the market and the only thing we learn from market history is that we continually refuse to learn from market history.

Breathe easy and spread the word.

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Thomas K. Brueckner

President & Chief Executive Officer

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