Sunday, November 20, 2011

Stock Market: Angry Without A Cause?

Movie bugs and fans of James Dean may like the movie "Rebel without a cause" (U.S. 1955  The current situation on the stock market reminds me somewhat of the title of this film. Last week we got lots of news that the U.S. economy is improving, but the US. stock market (S&P 500) dropped 3.8% -  the worst week in 2 months. Angry without a cause?

The U.S. economy may end 2011 growing at its fastest clip in 18 months as analysts increase their forecasts for the fourth quarter, reports Bloomberg (bloomberg). Bank economists are now upping their predicted growth rates for the gross domestic product (JPMorgan expects plus 3%, Morgan Stanley predicts 3.5%). “The incoming data on consumption, business spending and residential investment all points to GDP growth in the fourth quarter tracking 3.3 percent,” said John Herrmann, senior fixed-income strategist at State Street Global Markets to Bloomberg. Last week the media reported that the index of U.S. leading indicators, designed to foreshadow the economy’s performance over the next three to six months, rose 0.9% in October, the biggest jump since February, after a 0.1% September increase. They also reported growing retail sales, climbing industrial production and that the weekly jobless claims dropped again.

But the stock market ignored the positive facts and focused instead on speculation that Europe may drift into a recession and could draw the global economy with it. History shows that the stock market, at least in the short run, can separate from fundamental data. One example is the Flash Crash on May 6, 2010 in which the Dow Jones Industrial Average plunged about 1000 points—or about nine percent—only to recover those losses within minutes (wikipedia). Another example is the Black Monday on October 19, 1987 as the Dow Jones dropped 22%, following crashes in Hong Kong & Europe (wikipedia). Both crashes weren`t accompanied or followed by a weak economy. They also predicted  recessions which didn`t happen.

Those crashes are possible because in the short run stock markets can be dominated by sentiment. The movements of the stock prices can be sharply aggravated by the herding behavior of funds and other speculators, who tend to buy or sell when other market participants do the same. I believe that now the stock market is dominated by the wide spread doom & gloom sentiment and therefore underestimates the positive fundamental facts. If this belief is correct, the stock market now offers a buying opportunity.

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