	Generational Dynamics
	Forecasting America's Destiny ... and the World's

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Generational Dynamics Web Log for 30-Jul-06
Investors cheer at the good news: The economy's sinking.

Web Log - July, 2006

Investors cheer at the good news: The economy's sinking.

The stock market perversely took a big jump on Friday on news that GDP growth was sharply lower.

The economy grew at an annual rate of 2.5% in the second quarter, substantially lower than the 3-4% that had been predicted by economists. The downturn is attributed to reduced spending by consumers, resulting from high energy prices and the increasing cost of credit.

The Dept. of Commerce report specifically mentions deceleration in exports, and reduced consumer demand for durable goods (especially computers and cars), and a downturn in federal government spending. Also mentioned was a decrease in residential fixed investment. This reflects the end of the housing bubble, and reduced ability of consumers to refinance their homes.

Most of these negative factors are likely to continue. The price of credit has been going on and will not go down soon. The price of a barrel of oil in the last few years has gone from the $20s, then the $30s, then the $40s, then the $50s, then the $60s, and now has been over $70 per barrel for the last couple of months. A return to the good ol' days of cheap oil (and energy and gas) does not seem likely to happen.

So the factors that contributed to fall in GDP growth are likely to continue, and should continue to have a negative effect on the economy.

And yet, exuberant investors saw this as a reason to give the stock market a major boost. Major indexes increased by 1-2%. The DJIA rose 3.2% for the week, the highest weekly gain since November, 2004.

Why is bad news for the economy good news for investors? Because bad news for the economy means that is less likely to raise interest rates further, and raising interest rates further might be bad for the economy, so not raising interest rates further would be good for the economy.

If you think that doesn't make sense, you're right. Investors aren't thinking anywhere nearly that much. They've learned through experience that when some pundit says that the Fed will continue to raise rates, then the stock market goes down; if the pundit says that the Fed will stop raising rates, then the stock market goes up. If the news changes the next day, then the stock market reverses the next day.

We sometimes see the same thing with the price of oil. When oil was in the $40s per barrel, the stock market went up when oil went down, and vice versa. Well, if oil is now over $70 per barrel, then why isn't the stock market a lot lower than when oil was $45 a barrel?

On this web site, I frequently complain that no one considers anything important that happened before they were born. But investors are much worse than that -- they can't even remember what happened yesterday.

As usual, the question is: What's the real, actual value of a share of stock today, or the stock market as a whole? This is a question that no one ever seems to ask.

If you buy a car, then you have an idea in advance what you want to pay. If the price is higher than you expect, then you demand to know why.

Well, why don't investors ever demand to know why stock prices are higher?

There are two possibilities: Either you believe that stock market prices should be whatever the market determines, or you believe that stocks have "real" values like cars and other tangible goods.

The market today is priced at around Dow 11000. Is that the right price?

If you believe that stock market prices should be at whatever the market determines, then why not Dow 20000? Dow 50000? Dow 1 million? What's the difference? But if that's true, then of course it could also be Dow 10000, Dow 5000, Dow 1000? In this case, the stock market is no different than roulette wheel.

If you believe that the stock market has a "real" value, based on earnings, then there's no question where that computation comes out: The value of the stock market is around Dow 4500. The stock market today is overpriced by more than 200%, same as in 1929.

Either way, the stock market is overdue for a huge fall.

From the point of view of Generational Dynamics, we're been predicting since 2002 that the stock market would fall to the Dow 3000-4000 range. The fact that it will fall below 4500 is based on the law of "Mean Reversion."

We're still on the path for an early stock market crash, as I described in my May 30 essay, "Speculations about a stock market panic and crash."

Last month, I said that there are three possible ways to get off that path. None of those conditions have occurred. What we're seeing is that investors are not investing in individual stocks, but in the stock market as a whole, based on ridiculous reasoning like: If GDP growth is down, then the Fed won't raise interest rates, so it's time to buy. A stock market panic could occur tomorrow, next week, next year, or thereafter, but right now it still looks like a 50-50 chance that it will occur in the next few months, before the end of this year. (30-Jul-06) Permanent Link
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Generational Dynamics Web Log for 30-Jul-06 Investors cheer at the good news: The economy's sinking.

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Generational Dynamics Web Log for 30-Jul-06
Investors cheer at the good news: The economy's sinking.