In recent months, the stock market has actually acted “normal” in at least one respect. As the economy slowed last year, investors looked for any glimmer of good news. Even the slightest hint of prosperity down the road could be counted on to generate a rally, if only momentarily. Similarly, the wave of layoffs and shocks that hit the economy in the wake of September 11 brought corresponding drops in the major indices. In other words, good news was good news, and bad news was bad news.
This simple, commonsense relationship characterizes most aspects of our daily lives. Good things are good; bad things are bad; end of story. For much of the past decade, however, investors acted in just the opposite way. A positive economic statistic would dampen market performance; disappointing numbers would send it soaring. Good news was bad news, and bad news was good news.
The reason for this seeming perversion was really quite simple. The market was completely (overly) obsessed with interest rates, and the Federal Reserve was completely (overly) obsessed with inflation. Even though there had been no real evidence of rising prices for a decade or so, the Fed kept constant vigil.
Given this situation, any morsel of information about the strength of the economy agitated the Fed and fueled speculation that rates would soon rise. Since the market viewed a quarter-point increase in interest costs with approximately the same level of enthusiasm as multiple root canals on the same day, the reaction was to sell, sell, sell. Sure enough, stock prices tumbled.
The opposite chain of events was set in motion when the news was bad. The fears of a rate increase would ease, world peace would prevail, and markets would rally. The mere fact that this ebb and flow occurred several times each week is evidence enough of its asinine nature.
Well, folks, what goes around comes around. In recent weeks, definitive signs of a fledging business expansion have surfaced, and the Federal Reserve has been sending signals (both formal and informal) that future rate cuts are unlikely. There has been no discussion of raising rates or even a “bias” toward raising rates, but things are now more in a “neutral” mode (in case you don’t recognize it, that is Fedspeak). Moreover, while the economy is improving, we are a long way from a boom. In fact, because it is almost universally agreed that the Fed “overcorrected” (more Fedspeak) last time, you would think there might be some reluctance to raise rates at the first inkling of progress.
Nonetheless, the market is already reverting to its old pattern. It is again starting to obsess over minor wiggles in the numbers, and it is again sniffing around for the odor of inflation. Once more, good is bad, and bad is good.
The lessons from all of these machinations are really very clear. If you want to try to time the market or day trade, it is incumbent on you to reverse course and start thinking backwards. If, however, you just want to invest for the long haul, stocks perform well over decades if firms are profitable. In general, most companies do well when the economy is prospering and not-so-well during downturns. When you buy a stock, you are really buying nothing more than a slice of long-term performance expectations (properly discounted for risk). In that much simpler world, good news is always good news and bad news is always bad news. For what it’s worth, there has always been and will continue to be a lot more good than bad.