Models, Metaphors, Musical Chairs and Market Outlook
We'll have to see how the various themes play out over the next few days and several weeks. There's a couple of ways to think about this but one analogy I've heard (BigPicture, Minyanville, et.al.) is to think about the market as being lifted by four engines. But unlike a big jet the theory being that all four need to be providing power. Of course what are the four engines is a bit open to question and definition ( Disturbing Trends: Dividends & Earnings):
" Over the past few years, I have noted (repeatedly) that despite record earnings (Quarter after Q of double digit year-over-year gains), increasing dividends, M&A activity and rich Share buybacks, stocks have been very rangebound. The analogy I favor is that each of those four items are an engine of a 4-engined plane. With all four spinning mightily, most indices are about where they were (give or take a percent) 2, 3, or 4 years ago. Only the Dow is above its 2,000 highs.The danger of this four engined craft is that if any of the engines fail, the plane can be expected to lose altitude. Not crash into the mountains in a fiery conflagration, but seek a lower altitude before regaining stability."
Todd Harrison of Minyanville ( Measuring the market action that props up profits ) likes to look at his four table legs of Technicals, Psychology, Fundamentals and Structure (i.e. Dollar devaluation vs asset deflation). Actually there's a lot to be said for each. And they both make a good checklist of things to think about. Now Todd's column is very recent while Barry's is from lact Oct. which gives us another perespective.
I've also heard the four factors listed as Fundamentals, Technicals, Sentiment and Pscyhology so if we're not careful we'll end up with a 4 X 4 X 4 array of factors - which sounds intriguing but a little hard to work with. Maybe a little simplification and synthesis might be in order ? First off, we're all pretty agreed that Fundamentals are important and they're based on earnings which is in turn based on company performance and the economy.
Structure is a little hard to understand, at least for me but makes some sense after a while. In this case Barry's other three engines (Dividends, Buybacks & Buyouts) all seem to be related to a structural situation of high liquidities, credit and leverage; as well as low demand for investment in capital and hiring. At least we made that argument at some length in an earlier multi-part look at the situation ( Liquidity, Buyouts, Buybacks ) which might be another look to see if the argument works for you. Briefly we're in a world where low-growth lowers demand for investment while still throwing off lots of excess cash, further compounded by trade and foreign exchanges balances and petro-fund re-cycling. That's also a low-return world where excess investible funds chasing too few good opportunities leads to a desperation for higher returns and voila' ! The world of structured debt, leverage, CDOs, etc. etc. is called into being. A world which is still with us but increasingly thretend by mechanical breakdown.
Sentiment and Psychology makes sense to me but to some extent seem to be synonyms. On the other hand if we few sentiment as the outlook on things, in other words do we expect things to get better or worse remain the same or become more uncertain then we could view Psychology as the willingness to take risk or not, tolerance for ambiguity and uncertainty and so forth. But that almost brings us back full-circle, doesn't it ?
So it seems to me that a worthwhile checklist is Structure, Fundamentals, Technicals and Outlook (Sentiment, Psychology). Given that my original and primary interest was only in the hard, longer-term facts of structure and fundamentals admitting Technical issues took me a while. Yet the last several years, especially, since Barry's post form last Oct., certainly leaves the importance of Sentiment, at least in the short-run, very clear.
Somehwere in his large collection of pithy aphorisms based on insight and experience the Great Keynes said, among other things, something to the effect that "...markets are like musical chairs and when the music stops everyone rushes to find a seat. Except some of the seats get taken away... and what you're really doing is betting on which player will find which seat".
He put it much better than my paraphrase of course but that's the essence, to the best of my recollection. It also strikes me as powerfully useful and a good reminder. Just to really keep stretching the metaphor perhaps Structure = Chairs, Fundamentals = Chair presence, Technicals = Music and which players grab after which chairs = Outlook ?
About the time that Barry wrote his column the markets generally took off after spending the better part of three years (or more) being range-bound. At the same time we could see the Economy beginning to slow (at least in our analysis, more recently and now moreso). On the Structural side of things the deep & hidden risks in the credit markets (their roles in market demands & dynamics are in the Buyout and Buyback posts which agree pretty well with Barry's stance) became somewhat apparant this summer with the Bear blowup. Or did it - some commentators were issuing pretty serious warnings in the Winter ( a Lurking Debt Bomb ) and the Shanhai Surprise was another canary as well. But the Technicals have gotten nothing but "better" since last Fall, though volume and other indicators have gotten weaker. And several key markets, e.g. Emerging Markets, Technology, et.al. have been running ahead of even the more staid S&P and NYSE.
So if Fundamentals are deteriorating, Structure is increasingly unfavorable with a combination of increased credit risks and unknown (unknowable ???) values and the markets have headed up out of their trading range what's left ? Sentiment and Psychology would seem, by elimination, to be driving the chariot, wouldn't they ?
Based on the expectation for earnings next year, especially in Tech. Yet one has to wonder about that as well. ( Dr. Pangloss Treating Goldie; Tech, Tech, Who's Got the Tech...) . You're free, of course, to reach your own conclusions but it sure looks to me as if things are getting more than a little forthy - being driven more by momentum and positive psychology combined with a very sanguine sentiment than basics.
In the short-run though it seems to me that you'd want to let long bets ride, see how the markets behave and if we get some clarity but not make any major new long bets unless you're willing to let 'em ride for quite awhile (like years !).