The age-old Wall Street saying, “Markets make opinions,” suggests that the performance of stocks can heavily influence public sentiment about the economy. When stock prices rise, many view it as a sign of economic prosperity; conversely, when they plummet, the narrative shifts to an impending economic crisis.
This dynamic gives rise to a wide array of opinions. For instance, a flourishing NASDAQ may lead tech enthusiasts to declare that we are on the brink of a new digital age, while a decline in manufacturing stocks might prompt protectionists to blame agreements like NAFTA.
So, if markets shape opinions, do opinions in turn influence markets?
In recent years, the indecisiveness of the Federal Reserve has birthed a new, opinion-driven approach to market prediction. This method appears to involve analyzing economic data, predicting how it will affect Fed policy, and then determining its potential impact on the stock market. If we break it down, the correlation between economic reports and market activities can be summarized as follows:
Positive news often translates to negative reactions, while bad news can lead to unexpected optimism. This is generally true, except when, of course, good news is genuinely positive or bad news is authentically detrimental.
These relationships become apparent some of the time, but there are plenty of exceptions. Therefore, rather than relying solely on analytical thinking, some suggest trusting your instincts. This way, even in the face of mistakes, you can convince yourself you made the right call.
How to Invest Accordingly
For instance, imagine a government report declaring the economy is faltering. Surprisingly, this may lead to a rise in stock prices. Why?
The reasoning is straightforward: bad news is, counterintuitively, seen as favorable. The prevailing belief is that economic weakness will encourage the Fed to maintain lower interest rates for an extended period, boosting asset prices even higher.
Do you follow the reasoning? Should this influence your investment strategy?
Take this week’s example: the Conference Board Consumer Confidence Index recently rose by 4.4 points, reaching 101.1 in August. Consumers haven’t felt this optimistic about the business landscape and labor market in nearly a year. Additionally, the Commerce Department reported that consumer spending has increased for four consecutive months.
With consumers accounting for 70 percent of GDP, a rise in spending should ideally correlate with an increase in GDP. This piques the concern that the Fed might decide to raise interest rates in their upcoming September meeting.
According to the new conventional wisdom, this suggests that you should sell stocks. Why? Because a rate hike would likely reduce the liquidity that currently props up stock prices.
Shrewd Financial Analysis in the Year 2016
Yet, the answer is rarely as clear as it first appears. Rising consumer spending should logically lead to rising inflation. Increased demand fueled by greater spending typically drives prices up.
However, recent economic data tells a different story. The personal consumption expenditure price index, which the Fed considers its primary inflation gauge, remained flat in July. Over the past year, it has increased by only 0.8 percent.
Such low inflation is far from the Fed’s target of 2 percent. This might suggest that the Fed could delay any interest rate hikes until December. In that case, it would be wise to consider buying stocks.
Here, we find two seemingly contradictory economic reports: one indicating an uptick in consumer spending, and the other showing stagnant price inflation. Which report holds water? Which is flawed?
This line of inquiry often veers into the realm of nonsense. Yet it’s a narrative that seems to thrive in the media as astute financial analysis in 2016.
We mention this to illustrate that a vast majority of mainstream market analysis—derived from economic reports, interpretations of Fed policy, and eventual stock market implications—is largely an intellectual exercise lacking substance.
Sincerely,
MN Gordon
for Economic Prism
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