Warning: The Market is NOT the Economy

I love drug commercials.

Actually, it’s the composition of the commercials that I love. If a commercial lasts 1 minute – the first 25 seconds will show an attractive couple dancing freely and breathing clearly in a gorgeous, green prairie field. As the couple continues their dance, the latter 35 seconds includes a long list of possible side-effects that could result from taking the advertised drug.

For example, a simple allergy pill could cause drowsiness, dizziness or an upset stomach. You should call your doctor if you notice mood-changes, have difficulty urinating, or suffer from depression.

After hearing all of the potential side-effects, it almost makes you question whether you should challenge the allergy in the first place. Almost.

The Side-Effects of Funancials

Much like the allergy pill, my blog should come with a disclaimer.

What seems like a harmless, little article could have serious consequences when read on a weak stomach. I’ve been told that mood-changes and serious depression may occur.

I was actually told by a friend this week that “after reading your blog, I’m thinking about selling all of my stocks, going to the local coin show, and buying as much gold as I can.”

Obviously, I loved this idea. With the extremely accommodating monetary policy leading to an inevitable decline in the dollar, gold will surely be a benefactor. But, there’s no telling what will happen in the short-term.

The Market is NOT the Economy

I can’t believe I’m about to quote the worst economist ever, but John Maynard Keynes was once quoted saying something useful.

“The market can stay irrational longer than you can stay solvent.”

There’s a lot of truth to this. For instance, I’m always reminded of when the Bond King, Bill Gross, shorted U.S. Treasuries (a few years ago) only to see millions of other investors flock to the “safe-haven.” Millions continued to invest in Treasuries even as we were facing the first default in U.S. history coupled with a downgrade from Standard and Poor’s.

Along with being aware of the usual irrationality, you should also keep in mind that…

…there’s a disconnect between the market and the economy.

When I say that our economy is in shambles, it doesn’t necessarily mean that stocks will immediately suffer. For example, last year we were subjected to many congressional battles over fiscal policy, a global economy refusing to grow, and an increasing debt-crisis that needs to be tackled. All the while, stocks returned around 15%. Continuing into this year, when a slight pullback was expected by many, stocks continued their incline.

I found a great New York Times article that explains this disconnect. Senior Economist of the Vanguard Group, Roger Aliaga-Diaz, closely studied this relationship. He found that variables such as growth in GDP and corporate profits, forecasts of GDP and corporate earnings, government debt as a percentage of GDP, dividend yields, and interest rates on 10-year treasuries were “practically meaningless” when it comes to forecasting one-year stock market returns.

“Even over a 10-year time horizon, only P/E ratios had a meaningful, predictive quality.”

So…what’s an investor to do?

Stay tuned.