Stocks have started the year with a thunderclap, which is fitting because they are ushering in a new team in Washington that will intensify government's decision to play God with the markets.
Virtually every sentient fund manager seems to understand that this effort will likely end in tears, like all that engineering that tried to hold back hurricane flooding in New Orleans. But they're willing to suspend disbelief for a few weeks, or maybe even a few months, that our barren economy can be made fertile again through federally funded artificial insemination.
Leading the charge in this monkey-see, monkey-do market are a cadre of managers whom you might call the "smart consensus." These are folks who saw the 2008 debacle coming and have hidden out in bonds or cash through most of the past year. The argument among these reluctant bulls, articulated quite nicely by Ned Davis Research in a letter to clients a few days ago, is important to understand if you want to make some money at the start of this year.
Quite contrary
The reluctant bulls believe the global bear market that started last year was a forecast of global recession. Now that the forecast has proved accurate, it has sparked a huge global policy response from governments. They believe this response -- the rate cuts, quantitative easing and plans for fiscal stimulus -- will turn the global market trend higher early this year in anticipation of improved economic performance in the second half of the year.- For views on the economy, play the video to the right.
Got that? The market forecast the economic decline, and now the market is supposed to forecast a recovery. The key view among optimists now is that because all asset classes -- U.S. stocks, international stocks, commodities, etc. -- tanked in the fall, that's evidence that a majority of investors had come to believe that credit conditions and the economy would remain lousy throughout 2009. And since the majority must be wrong -- as it so often is when it comes to investing -- those doubts are unlikely to be realized.
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Pretty tricky. So the smart consensus now believes so much bad news has been priced into stocks that the market is susceptible to positive surprises and that stocks will rally with a vengeance once fear abates. Davis conjectures that once the dam breaks and hope replaces alarm, the top performers will be the volatile sectors and regions that are now the most oversold. He sees potential for small-capitalization stocks, commodities and emerging markets to lead.
This actually makes sense, in a cynical sort of way. The market's broadening rally and greatly diminished selling intensity show the process has already begun. The flaw in the argument -- so far, at least -- is that outside of energy there's been little of the intensity to the buying that is typically seen at the start of a bull market. According to statistical work done by Paul Desmond at Lowry's Reports, almost all of the advance can be attributed to a big drop in selling intensity rather than to an increase in buying. And you really need the two to tango.
Is that a fatal flaw? We'll see soon enough. But in the meantime, let's look at more details about what members of the smart consensus see ahead, since they've already proved they have the ambition and ammo to drive stocks forward while sellers step to the sidelines.
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The economy's real problemThe money that the Federal Reserve and Treasury are giving away is going right back to the Fed. The financial fixes haven't worked, Jim Jubak says, because banks aren't lending out the money.
Emerging, again
Among all emerging markets, they see China and South America as the most likely to move a lot higher, which makes sense because their respective exchange-traded funds -- iShares FTSE/Xinchua China 25 Index (FXI, news, msgs) and iShares S&P Latin America 40 Index (ILF, news, msgs) -- have stabilized and have doubled the return of the S&P 500 Index ($INX) since its late-November low.The market's message here, according to Davis, is that investors believe the economies of China and Latin America will recover faster than those more directly exposed to the credit crisis. The message also suggests China will react well to Beijing's fiscal and monetary stimulus and benefit greatly from lower oil and commodity prices. This is a powerful idea, and although I have my doubts that China will recover quickly from the mess it has gotten into from overbuilding, it usually pays to respect the market when it speaks so distinctly.
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