Monday, March 30, 2009

We're in Danger of Being Blinded by Market Bottom Predictions

Yesterday morning I read a brilliant article analyzing the market bottom: “Markets Have Hit a Bottom, But Is It THE Bottom?” by Eric Coffin, a contributor to Seeking Alpha, where I saw the article posted. Coffin does a great job taking a look at various economic fundamentals from the price of copper to the actions of the Fed.

He comes to the conclusion that although there are some positive signs out there, too much volatility remains to make any firm predictions about whether the market has hit a true bottom or not. I agree with him, but I also have a major problem with the value of his predictions. In fact, virtually every day I read articles on Seeking Alpha that are similarly brilliant and argue either for or against the market bottom and direction. Each makes a similar mistake.

The Quality Of Any Market Analysis Is Directly Related To The Scope Of The Analysis Beyond Economic And Market Factors.

I have thought for some time that the current global crisis in its most basic terms is not attributable to economic and market factors but to cultural factors. Every segment of our society, from construction worker to web designer to lawyer, investors, bankers, home buyers - all of this society - lived with certain standards and motivations that took us straight to where we ended up.

In most basic terms, it was a consumer society where the most important activity was to buy: buy newer, bigger, better, more expensive, higher tech, but buy even if it is with money you do not have.

Yes, that had clear economic consequences, but it had other consequences in terms of lifestyle. That lifestyle may be replicated again at some point in the future, but it will probably take a generation or two.

If my premise is correct, that this crisis is basically due to cultural issues, then it would also be correct to assume that the crisis will result in cultural changes. Some of them are likely to have a dramatic impact on the economy and the stock market, both in terms of degree and quickness.

Among the most dramatic possibilities is the prospect of political upheaval. For example, I discussed the political issues that will swirl around the G20 in an article that was also published by Seeking Alpha, and also in a detailed look at protests of the middle/working class around the world.

Political volatility is not a part of Mr. Coffin’s analysis of the market bottom, but what would happen to the market if riots broke out within a few days of each other in various locations throughout the world? How will the world (consumers, investors, bankers …) react to those headlines? I am not predicting that those headlines will occur, but I find it hard to dismiss the prospect that they could occur. To ignore that when trying to determine a market bottom is to have a basic flaw in the analysis.

Similarly, an analysis that considers the possibility of improved earnings driving a market recovery needs to include some consideration of how the consumer might change culturally. For example, in his column in yesterday’s New York Times, (”Darkness Down The Road“), David Leonhardt raises this fundamental question: “There is no doubt that the economy is in terrible shape. The overall volume of loans is, in fact, falling. But is that because banks won’t lend? Or because businesses and families don’t want to borrow?”

To come to an answer, Leonhardt focuses on one industry: the rental car business. In addition to an analysis of the balance sheets of the major industry players that is revealing, he notes: Overall industry purchases are down 63 percent relative to early last year, and all three companies have also laid off workers. Why?

Because the economy is in terrible shape. Fewer people are traveling and renting cars. The companies already own too many cars, thanks to the sweetheart deals that Detroit offered in recent years to clear out its bloated inventory. ’From our standpoint, there is no liquidity crisis,’ says Patrick Farrell, an Enterprise vice president. ‘We’re buying fewer cars because we need fewer cars.’”

Interesting. To what degree will the lesser use of rental cars become a cultural legacy of the current crisis that will extend beyond the crisis itself? Have all the industries been identified that are going to be impacted even to some degree by cultural changes? In very real terms, this crisis is just starting to be absorbed by the public; so can we even start to predict how they will change? The certainty of a prediction about the bottom of the market is directly related to the uncertainty of cultural changes yet to come. I think there are a great deal.

Then there is the direction of the political philosophy of the U.S. We do not know yet just how far towards a more centralized government we will go. I do not think a market bottom can be predicted without taking into account what the role of the government will be two or three years from now.

I do believe there is great value in analysis of economic and market conditions and trends. But, I am increasingly convinced - and concerned - that non-economic and non-market factors will have a dramatically greater impact than most people currently factor into their predictions.

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