NEW YORK ( Real Money) --
"For most private investors, the bad news is good news for stocks story just doesn't pass the smell test."
I saw that tweet this morning and I wrote in return that "it's always been like this."
The follower then came back to the effect that even if it is has always been like this, that doesn't make it right.
And there' that word again: "right." I think that "right" has to be the most expensive word in the business. This is not an ethics class. It isn't an exercise in some bizarre form of justice.
Yet what seems obvious to me appears opaque to others, and I seem like someone who wants to get away with something, while those who think it's not right represent the true path of reason.
How did this happen? How could so many people feel like @PaulKinglsey, who typed that tweet?
I think that debunking the tweet's misperception is central to trying to figure out the next leg of this market, because it holds the key to whether stocks can attain a higher level than we have reached already.
First, there is no smell test. When you invest in stocks you are trying to divine the direction the market will take. That requires lots of history and lots of pattern recognition and a lot of homework. Some, such as technicians, often think that pattern recognition is all that matters. Others think the whole exercise is wrong and they just look as stocks as an investment class that had done well over time so you need to own some of it.
Others, me included, like the pattern recognition and the quality of the asset class and believe that the best-of-breed stocks within that asset class can be discovered and exploited. Nowhere within the trio of reasons to own stocks is a smell test. What you are betting with when you invest when bad news is good news is the history leading up to when the economy flips into high gear and good news is good news. That's an explosive time for the market and you have to invest during the bad-news-is-good-news phase in order to reap the biggest gains. In other words, you have to be early and you have to anticipate.
If you wait until the tweeter wants the market to smell good, you have probably missed a great deal of the move.
Now here is where a lot of judgment gets clouded. There are plenty of people who believe that the Federal Reserve is life support for the stock market and when you take away the life support the stock market dies. These people do not know the history of the market, as encompassed by "don't fight the Fed" and "don't fight the tape" or, alternatively, they are so blinded by politics, which since the polarizing world of President Obama and Congress, now infects even the process of making money in the market.
I think it is a false link. Those who believe in the politically incorrect nature of what happened in this run -- that it is spurred only by the Fed -- missed out on a tons of money. I often think they don't care. That's because they are not investors. They are politicians masked as investors. Their views have to be avoided at all costs because they are not central to the process.
Second, those who think that the stock market can never transition into an earnings-derived advance don't understand sector rotation. When they say "this market," they are simply being brainwashed by trading in the futures as a market as a whole. That, too, is not investing. That's asset-class choosing and it's been dead wrong, too. The dominant asset class success story in my lifetime has been in the fixed-income world, not stocks, with the 30-year Treasury offering by far the best risk-reward during my career, which began in 1979.
But if you are a stock picker, you know that the most enjoyable, even most predictable, element of the market comes when earnings aren't manufactured by cost cuts but are generated by higher sales overlaid on a lean organization.
That's where we are now. That's what we saw Friday. We are getting many signs that the international companies that are based here are now experiencing the transition from earnings-oriented investing -- something that's been quite bountiful -- to sales-oriented investing. When that occurs, the market can really gallop.
In the meantime, there are plenty of people still betting that the tapering will be held off. They are the Clorox (CLX) investors, still attracted to slight growth with some yield. There are so many hedge funds betting against a limited batch of securities such as Clorox that there is a bizarre funnel effect of shorts covering, longs unwilling to sell because of gains and a nice dividend and outright share repurchases that shrink the float. There were 153 million shares of Clorox a little more than five years ago, and now there are about 132 million. That missing 31 million explains more of the move than people realize. It makes for hard shorting and easy owning.
Now it is true that we could lose Clorox in the transition to higher earnings, although that sure hasn't happened yet. But anyone who knows the history knows that we now should be shifting to the bank financials. The money should come out of the non-bank financials as well as from the rest of the market and flow right into the banks. They haven't been allowed to shrink the float because the government keeps them from doing so, but it could occur soon.
These investors might be drawn to technology, especially now that the personal computer class of tech seems to be bottoming as we have seen from the moves in Microsoft (MSFT), Western Digital (WDC), Seagate (STX), Hewlett-Packard (HPQ) and, most recently, Intel (INTC). And they might be interested in retail recognizing that things could get better than they are right now if the economy improves because of the possibility of more jobs and therefore more disposable income.
The political types are already citing the new health care regime as a reason to sell stocks, but that might prove to be wrong because the large companies are precisely the ones that can navigate these new waters. Their smaller-capitalization and private small-company rivals are the ones that should fall by the wayside. That will soon be seen as logical, but a lack of business savvy by the White House didn't see this coming any more than it didn't see the Web site issues coming.
So, to sum up, the smell test does get vindicated back-handedly by the transition that has historically occurred now. The investing that has come previous to this moment is from people who recognize that bad news has historically led to good news and they have been driven by individual stock performance as well as pattern recognition. The asset-class hunters and the corporate buybacks have been convenient props to the whole process, which is why this move that is so explosive, the one that shouldn't be happening, is indeed prevailing.
I feel badly for those who wait for things to smell better. They may not know history. They might be confused by politics and the need to have a balance between a bull and a bear debate driven by politics. But they, in the end, shouldn't be pitied. They convinced themselves they were right and by doing so they were perfectly willing to forgo the gains to date.
I think they will most likely forego the next set of gains, too. A combination of blindness from the inability to believe that stocks can really rally under Obama, coupled with an underestimation of the Federal Reserve's will, abetted by the nonpolitical historical buyers who are not now going to turn sellers precisely because they know the history and fear a stock shortage among seasoned equities -- the IPO market has provided tons of unseasoned and often disrespected fodder -- could end up propelling us to the next level. Oh, and believe me, to these purists, that advance will stink to high heaven, too.At the time of publication, Action Alerts PLUS, which Cramer co-manages as a charitable trust, had no positions in stocks mentioned.
Editor's Note: This article was originally published at 7:24 a.m. EST on Real Money on Dec. 9.