Wall Street Plays Oldies
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A cooling economy -- along with lower interest rates and energy prices -- has served to buoy markets in a "Summer Love In" for stocks.
Arguably, the advance has now ushered in a sense of conformity. Of course, the ever-present risk of a contrarian (read: bear!) is that the past literally does repeat itself and that the crowd outsmarts the remnant. And while historical relationships almost always hold true as a prologue to tomorrow, it does not say which lesson to apply and when.
Rising geopolitical risks (and Middle East instability) coupled with the likely broad ramifications of a hard landing in housing have all but been ignored. The rise off the recent lows has been impressive, emboldening previously worried investors who have increasingly begun to worship at the "Altar of Momentum."I have spent a lot of time on The Edge discussing the negative impact that a sharp decline in homebuilding activity and cash-out refinancings will have on the economy in general, and the consumer in particular. The following chart indicates -- with a reasonably high probability (an R squared of 0.64) -- that when the index of homebuilders drops, a broader decline in the major indices is not far behind. With fear and doubt all but driven from Wall Street, a marked correction in stocks can happen at any time. The market's behavior during this summer is starting to look technically similar to the advance of August-October 1973 -- which also started off an unimpressive bottom -- that fizzled rather quickly as equities entered a bear market in 1974. Conformity often pays off in markets -- as New York Times Op Ed editor David Brooks points out regarding cultural issues of the 1950s in his references to Grace Metalious' Peyton Place. That novel produced a message -- to engage in high-risk searches for unpleasant truths -- that speaks not only about the repressive bourgeois a half-century ago but also volumes to investors during the summer of 2006.
From my perch, that search could produce a panoply of negative outcomes (sharply lower corporate profit margins, an adjustment downward of consumer expenditures and stubbornly high inflation). And it might produce, to paraphrase another lyric from "Grease": "Summer dreams are (about to be) ripped at the seams ... but oh, those summer nights!"
As Brooks recounts in Sunday's Times (though on a far different subject), the market's line between bulls and bears is now clearly drawn. And perhaps he is correct in the notion "that there's actually more conformity and complacency (today) than even in the 1950s," though not at Peyton Place, but at the corner of Broad and Wall.
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