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The Stock Market is Not the Economy

Published: 10/11/11 at 11:00 AM ET
 

Last week, we conducted a short survey of our Dick Davis Investment Digest subscribers. One of the questions asked them to identify the biggest concern or challenge they face as investors right now. The top two answers were market volatility and the economy. Several respondents used the phrase "economic uncertainty."

Obviously, our subscribers' concerns are valid: the economy's direction is, indeed, uncertain. However, the obvious level of concern over this makes me think I should revisit a point I wrote about here a few months ago. Simply, the stock market is not the economy. The market can, and frequently does, move counter to the rate of U.S. GDP growth.

The stock market's post-recession recovery began far earlier in 2009 than the broad economy's. And while the stock market now appears to be reflecting fears of a double-dip recession, this prospect has been menacing us for over two years now, and the market has gone both up and down in that time.

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Analysis of news headlines shows reporters trotting out economic worries as a sort of explanation every time the stock market declines, strengthening the mental correlation between the two. Headlines like "Wall Street Slide Sparks Double Dip Concern" and "Stock Market Tumbles as Fears of Global Slowdown Rise" are the same every time; the first is from last July and the second from last week.

Faced with this constant intermingling, it's important to remind ourselves, once again, that the stock market is not the economy. This was the focus of the Market Outlook section of a recent Investment Digest, and I want to share some of that wisdom with you today. Stephen Todd, editor of Todd Market Forecast, wrote:

"It's astonishing. I keep hearing financial commentators, many of whom have long experience, suggest that the market can't make headway for the remainder of the calendar year because the economy is so poor. To this we say nonsense. From March 2009 until April 2011, the Dow rose 6,200 points or 92%. During that time, the economy was in the doldrums. To be specific, the unemployment rate went from an already high 8.5% to an even higher 9.1% during that period, even touching as high as 10.2% at one point.

"The closest analogue to the current time frame is the early 1980s. Like now, unemployment was sky high, but by the time the jobs picture really started improving the market was already up 40%.

"Do yourself a favor, don't look at the economy when analyzing the stock market. It will just confuse you... After the market closed on August 5, Standard & Poor's downgraded the debt of the United States and a severe knee-jerk reaction took place the following Monday. The Dow lost over 600 points, but within six market days, the market had made up the entire loss, and bonds, which were supposed to suffer from the downgrade, surged. You have to wonder how bad things really are when our bonds are surging. Contrast this to Greece, where bonds are collapsing."

Gregory Spear, editor of The Spear Report, wrote (under the headline "It's Not the Economy, Stupid"):

"Naturally, investors in the U.S. are pricing in a double-dip recession, but this week we learned that the ISM Services report for August was stronger than expected, improving from 52.7 in July to 53.3. Why? The back-to-school shopping season was actually decent. Are consumers simply whistling past the graveyard? If it is not the economy, then what?

"Current market volatility is certainly more about confidence than consumption. This is the metric that accords with the 13% decline in the S&P 500 since early July. But when it is virtually impossible to find a piece of good news on the financial pages, when the pompous pundits of perdition are gloating, our contrarian voice gets even louder. After all, if everyone is scared to death, they have probably already acted on their fears, or are about to. The darkest hour is just before dawn and dawn is a good time to pick up bargains left for dead on the Street. In our view, the only question is whether it is dark enough yet. Unfortunately, we still see a lot of lights on in Europe."

Finally, John Buckingham, editor of The Prudent Speculator, added:

"We also remember that we are investing in business and not directly in the U.S. economy. As Fed Chairman Bernanke said last week, 'The business sector generally presents a more upbeat picture (than the household sector). Manufacturing production has risen nearly 15% since its trough, driven importantly by growth in exports. Indeed, the U.S. trade deficit has narrowed substantially relative to where it was before the crisis, reflecting in part the improved competitiveness of U.S. goods and services. Business investment in equipment and software has also continued to expand. Corporate balance sheets are healthy, and although corporate bond markets have tightened somewhat of late, companies with access to the bond markets have generally had little difficulty obtaining credit on favorable terms.'

"To be sure, the path of least resistance in the near term seems to be to the downside, with yet another (it was hit on August 8, August 10, August 19 and August 22) retest of the 1,120 level on the S&P 500 seemingly in the cards. Nevertheless, we continue to think that those who share our long-term, three-to-five year investment time horizon should be maintaining their equity exposure and selectively adding to their portfolios, especially if stocks move lower still."

Obviously, bad economic news, general fear and lack of confidence can all weigh on investors' minds, keeping them from buying. But at the end of the day, it's investors, not the economy, that determines which direction the market goes.

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Today's stock is one from the bargain basement. Goodyear Tire & Rubber Company (GT) tanked with the market in early August, and has yet to get back on its feet. But AlphaProfit Sector Investors' Newsletter Editor Sam Subramanian doesn't think there's anything wrong with the company, and sees a buying opportunity here. Here's his recommendation, from last month, which was in the latest Digest:

"The Goodyear Tire & Rubber Company shares are down sharply from their $18.25 a share July high. The tire maker's fundamentals are on a sound footing and the decline represents a buying opportunity. In the second quarter, Goodyear left analysts' forecasts in the dust by reporting revenue and EPS surprises of 8% and 141%, respectively. Goodyear targets to save $1 billion in costs by 2012. While rising raw material costs, intense competition and the company's underfunded pension pose risks for Goodyear shareholders, the shares trade at 7X forward EPS and offer good value for long-term investors. Buy Goodyear Tire & Rubber Company Below: $10.60. Sell Above: $12.85. Stop-Loss: $5.50. Risk Rating: Above Average."

Click here to learn more about GT and dozens of other recommendations from some of the top minds on Wall Street.

Wishing you success in your investing and beyond,

Chloe Lutts
Editor of Investment of the Week

  

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