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Generational Dynamics Web Log for 22-Apr-05
Giddy, ebullient investors push stocks to highest gain in years

Web Log - April, 2005

Giddy, ebullient investors push stocks to highest gain in years

Wild turbulence continues as stocks close 2% higher after week's 7% fall.

All three major Wall Street indexes -- the Dow, the S&P 500 and the Nasdaq -- rose 2% to 2.5% Thursday, in the largest gain since October 2003.

And as of midday Friday, Japan's Nikkei index is following suit with a 2% jump. (Update: By end of day Friday, the Nikkei is making only a 0.55% jump.)

Commentators are expressing ebullience. On Thursday's NPR Marketplace business program, host David Brown referred to the "broad smiles" on the faces of investors.

Anyone who's been reading this web site for a while knows that I'm a curmudgeon who's critical of most of what passes for financial commentary today, but this giddiness is almost beyond belief.

DJIA, April 21 2004-2005

DJIA, April 21 2004-2005

The market has been going up and down for the last year or more, as the adjoining graph shows. But in the last few weeks, these oscillations have been getting more rapid, making the market increasingly volatile. As we wrote about yesterday (see next item, below), this doesn't necessarily mean that a crash is imminent, but this is the behavior that always precedes a crash.

Let's take a look at the psychology of what's going on. Why would investors sell so much for a few days, and then buy so much on the next day?

Dow Jones Industrial Average - the trend value in 2006 is 4900; in 2010 it's 5800

Dow Jones Industrial Average - the trend value in 2006 is 4900; in 2010 it's 5800

First of all, the stock market is a bubble floating in mid-air. Stock prices today have no relationship to the actual values of the companies they represent, as the adjoining graph shows. As we've previous described, the actual value of the companies being represented is shown the the long-term trend line, which has a value of 4900 in 2006 and 5800 in 2010. These values are far below todays stock market prices, above Dow 10000, indicating that today's stock market is some 100% overpriced.

Under normal circumstances, the stock market will oscillate around that line, with stock prices sometimes a little overpriced, and sometimes a little underpriced.

But something went wrong in the 1920s and the 1990s bubbles, when stock prices went high above their underlying values, and price/earnings ratios went into the 20s or 30s or higher. Today, stock prices are still in bubble territory.

So if today's stock prices have no real relationship to the companies they represent, then why does the market go up and down on a daily basis?

This is "behaviorial economics" gone amok. Investors use faulty data based on faulty theoretical models. In fact, I've written several times about the nutty misinterpretations of price/earnings ratios used by financial analysts who try to hide the fact that almost all stocks are overpriced.

When you look at investors' decision making process, you see that there's been a dramatic change in the last few months. In "normal times," investors make decisions about buying or selling individual stocks. But today, investors are making decisions based on whether the market as a whole will go up or down on a daily basis.

This means that investors are following a "herd mentality," all tending to move in the same direction, dictated by the market as a whole, rather than in different directions, dictated by individual stocks.

It's the volatility of the market that indicates that the herd mentality is going on, and the greater the volatility, the greater the herd mentality.

In "normal times," an individual stock can be highly volatile, as investors as a group sell off the stock or buy the stock heavily, based on rumors or emotions or real data.

Today, with investors moving in unison, the whole stock market is becoming more and more volatile, and the stock market as a whole moves up or down, based on rumors or emotions or real data. And that means that, one of these days, there will be a sharp selloff.

My original prediction, made in 2002, based on generational analysis and standard growth analysis, was that we would have a major stock market crash (DOW down to 3000-4000 range, S&P 500 index down to 400) by 2006 or 2007. This MUST happen sooner or later because stocks are so far overpriced. The rapidly increasing volatility of the market indicates that that day is coming sooner rather than later. (22-Apr-05) Permanent Link
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Generational Dynamics Web Log for 22-Apr-05 Giddy, ebullient investors push stocks to highest gain in years

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Generational Dynamics Web Log for 22-Apr-05
Giddy, ebullient investors push stocks to highest gain in years