Why the Stock Market is Such a Difficult Place to Ply a Trade

United Steel (X), along with any number of names of late … Capital One Financial (COF), Harley Davidson (HOG) come to mind but I am seeing many other examples… showcase why the stock market is such a difficult place to ply a trade. The latter two stocks were names I was attempting to short summer 2009 after the cursory bounce in March 2009. By summer they had run up substantially, were no longer oversold, and were (in my opinion) over inflated in valuation based on what I viewed was reality in the economy. But the stock market is about perception & “the playbook” . The playbook said a wonderful economic recovery was coming because after a large drop in the economy, must come a substantial rebound. Everyone in the ivory tower says so, the textbooks say so – thus it must be. The exact same rigid thinking that had Ben Bernanke and most major Wall Street strategists miss almost this entire disaster.

I, on the other hand, believed this was a government morphine laced printing press “recovery” and while of course we could not continue down into the abyss at the rate we were going (otherwise there would be no economy at all within a few years), investors were well ahead of themselves in their belief system. The US has massive structural problems, and people are confusing the cyclical oversold bounce in the economy (mostly caused by never before seen levels government spending) with some sort of grand recovery or a return to good times. As if a multi decade debt binge was solved in 15 months… all it takes is a Federal Reserve willing to throw every saver in the country under a bus, and a few changes in accounting rules for the banks. Problem solved.

So these stocks bounced, and ran… and ran… and ran… and ran. Steam rolling anyone with my belief system. It really didn’t matter if I was right eventually about the economy and this misguided belief system by the “all knowing market”. You still get steamrolled. It is almost a negative to have too far of a timeline in the stock market – because perception is reality in the intermediate to near term. If (almost) everyone believes in something, they will buy in anticipation of it. [Part of the reason I am in awe of the commodity rally – which institutions have piled into due to (ex China) some wonderful recovery coming – that’s what the playbook says to do!]. It really does not matter at the time what the eventual outcome is when we arrive to the destination – the journey is the thing. I warned about this last spring but “the disassociation” surpassed all my expectations.  I vastly understated the power of a printing press gone wild. [April 3, 2009: The Current (and Coming) Disassociation Between Wall Street and Main Street]

While only the journey mattered back then, the destination (‘the new normal’) is around the corner and all those who bought in anticipation of a return to “old normal” are being disappointed. The performance of United Steel (X) – down 1/3rd in just 5 sessions – showcases what happens when reality trumps perception. But that is of little help to all those who RIGHTLY said these green shoots were mostly myth, and certainly had little to do with organic* strength in the US.

*ex-government

(by the way, if you are insistent that the economy is just fine – this is a place to put your chips on X as its right at long term support – with a tight stop loss of course)

Even many of the companies trouncing their earnings estimates are doing so by the same method – cost cutting (slashing workforce), getting any strength via overseas or simply playing the “lower expectations and then beat them” game. I am reading the exact same data points in earnings report after earnings report among the larger players –

  1. “US demand bounced off year ago lows and we’re looking forward to more recovery in 2010 but have yet to see it.”
  2. “Inventory restocking happening..”
  3. “Asia is almost back to pre 2008 levels, but United States nowhere close”
  4. “While industry is rebuilding inventories, we are seeing a lack of end demand in the US consumer”

I feel like I am reading the exact same earnings report over… and over… and over – with of course a few exceptions. These CEOs sound like an army of zombies repeating the same quotes. Point #4 above is so important to me – businesses are rebuilding inventories but without your end demand you have nothing. Most of US consumer end demand – outside the top 5-10% of the economic pay scale – comes now from direct bribes by government – buy cars, buy houses, here’s a rebate check, go shop! Capital One Financial’s CEO on the (still extremely) indebted US consumer:

“The lack of consumer demand for credit, across our businesses, is striking,” said Capital One Chief Executive Richard Fairbank during the company’s earnings call late on Thursday.

Perhaps the ever blunt CEO of Nucor (NUE), United Steel’s competitor summarized it best:

“The fact is, the market stinks … no product group, no product type, no end market is anywhere near back to where it was two years ago. Raw material costs are putting pressure on everybody.”

Yet steel stocks have rocketed for months on end…. because every guy on Wall Street has the same playbook. As have stocks in any other “cyclical” sector.

Bottom line, don’t believe the hype that the market is “efficient” or “a great forward looking mechanism”. What was it looking “forward” at in March 2000? Or October 2007? (When markets were at all time highs) The only thing the market is great at in the near term is acting as a wonderful group psychology experiment. As long as the lemmings all run in one direction holding hands in their belief (waving their textbooks high in the air) it doesn’t matter if the market is right or wrong. You will get run over if you bet against them in the near term. Their perception is all our reality. The only problem is you just never know when reality finally trumps perception or textbooks. Which is why this is one difficult game – logic means little much of the time – and I marvel at how many stocks I bet against last summer are now facing “reality”.

Our problems were not “solved” in 15 months… we have a long path of deleveraging ahead. To believe otherwise is to believe in fairy tales. Or CNBC pundits.

Disclosure: No positions

About Mark Hanna 543 Articles

Affiliation: Hanna Capital, LLC

Mark Hanna is President and Owner of Hanna Capital, LLC, a registered investment advisory firm. Mark has been a follower of markets since the late 80s, with a focus on individual equities since the mid 90s. He has been a well known commentator in the financial blogosphere for the past 5 years, following a career in corpoporate finance and accounting. Mark attended the University of Michigan where he graduated with a degree in Economics.

As an avid reader, Market Montage is the personal blogging site for Mark to share his views on economics, markets, and the like. Occasional cynicism and wit shall be deployed in his postings.

Follow Mark on Twitter @fundmyfund.

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