The Fundamentals Stink: Buy Stocks

"The most costly of all follies is to believe passionately in the palpably not true. It is the chief occupation of mankind." -- H. L. Mencken

Fundamentals don't matter.

Earnings are irrelevant.

Economic expansion is meaningless.

You may disagree with those statements, but consider this: How accurate are the average investors' perceptions of these issues? And how much does it really matter?

The short answer to both questions is "not very." But the longer answer is more interesting: It may not matter if the crowd is wrong -- at least, not in the short run -- because the crowd is the market. If the mass of investors believes something and acts upon it, traders shouldn't really care if the emperor has no clothes.

To be clear, there will come a time -- there always comes a time -- when the crowd's collective delusion gives way to an unpleasant reality. This often comes near market tops or bottoms, and the crowd, unfortunately, tends to realize this quite late.

Subjective vs. Objective Reality

A large part of my job involves finessing my way through myriad data points. Not taking them at face value, but drilling beneath the headlines to discover what is truly going on in the markets and the economy.

My working presumption is that markets do well in advance of and during periods of robust economic expansion. They fare less well when they anticipate an economic contraction. While the timing may often have a coinciding overlap, the biggest market gains come from anticipating major shifts early in their cycle, and catching these key macroeconomic reversals.

I've discussed variant perceptions before, and it is a very useful concept for investors. If you can recognize when the crowd misunderstands a fundamental aspect of the market, that's an edge you can take advantage of. The tricky part is the timing: When will the masses learn that their subjective reality is false, and move closer toward your understanding -- subjective though it may be -- of the economic universe?

---

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.