Business economists and security analysts no less than traders and investors are prone to herd behavior. (Academic economists are somewhat but not entirely immune.) This herd behavior -- the comfort of being in the middle of the herd rather than a maverick outlier exposed to the danger of being both wrong and alone -- is probably one of the main reasons that the consensus of market opinion about the economy is at such unusual variance from the current flow of economic information as well as the behavior of the market itself. The actual behavior of the bond market where interest yields are under strong downward pressure is screaming stagnation and deflation risk, but this is totally at variance with the conventional wisdom forecasting sharply higher yields. And while bullish sentiment is still strong in the stock market, even there institutional money managers have until very recently been dumping riskier high-multiple growth stocks for the safety of defensive dividend-paying value stocks.
Despite the very disappointing economic data of the last couple of weeks, stock market bullish sentiment seems to have gained the upper hand over the more cautious safety seeking money managers and the bond market which always gives much more attention to economic data than the stock market. While stock market analysts can take comfort in the stock buybacks and other forms of financial engineering that is keeping earnings going up (though at a slower pace), bond analysts have little to consider in formulating their strategies besides the flow of economic data. Stock prices have therefore shown signs of bottoming and the broad based S&P500 benchmark has even moved up into new high ground while bond yields sink signaling a weaker economy.
Despite the very disappointing economic data of the last couple of weeks, stock market bullish sentiment seems to have gained the upper hand over the more cautious safety seeking money managers and the bond market which always gives much more attention to economic data than the stock market. While stock market analysts can take comfort in the stock buybacks and other forms of financial engineering that is keeping earnings going up (though at a slower pace), bond analysts have little to consider in formulating their strategies besides the flow of economic data. Stock prices have therefore shown signs of bottoming and the broad based S&P500 benchmark has even moved up into new high ground while bond yields sink signaling a weaker economy.
When you stop and think about it, the herd behavior is quite rational. It might make sense for an ambitious trader or hedge fund manager to go out on a limb with a maverick strategy. If right he can be richly rewarded with huge profits like a Paulson who bet correctly on the sub-prime mortgage disaster; if wrong … well maybe he can start over again. But there are no huge bonuses for business economists or security analysts who turn maverick, only raised eyebrows from their superiors. If they are right they will get a pat on the back and a few words of praise, if wrong they will be fired and never get another job in the industry.
I have just finished reading a few of the latest weekly reports by the economics departments of some of the largest banks, and it is astonishing how they have dismissed the first quarter’s sharply lower GDP figures, the downward revised business investment and standstill of the housing market as consequences of the harsh winter. Come on! The center of gravity of the economy is no longer in the Northeast and MidWest, it is in the Sun Belt, and sure we had two days of ice and snow here in Atlanta, there were a few cold days in Texas, and a drought in California, but not enough to send even a ripple through the economy! And what about April, the start of the second quarter, when the consumer was supposed to come out of hibernation and carpenters could start swinging their hammers again on all the new homes under construction. How do they explain the fact that the growth of consumer spending in April accounting for 70% of the economy was actually negative in both nominal and real terms? The fact that sales of durable goods slumped well below expectations? And the only housing growth was in multifamily apartments accounting for only 17% of the housing market while applications for mortgages dropped to a 3 year low?
This herd behavior among economists and security analysts is worrisome, because once the data becomes overwhelming and they are forced by the sheer logic of the numbers to revise their forecasts, the herd is likely to stampede towards lower estimates. Fundamentally, I think the economy matters less to the stock market than Fed policy, and weak economic numbers makes it more likely that the Fed will continue its stimulus, but changed expectations on the economy would be a blow to sentiment that could derail the bull market in stocks at least temporarily.
The danger is nearby. Wells Fargo’s economists have bravely set aside all the negative economic data in their latest reports with assurances that it was caused by the weather, and that the economy, including the moribund housing market and consumers that are Wells Fargo’s life’s blood, would come roaring back during the rest of the year. At the same time however, the logic of the new data was so compelling that they were forced to revise their full year GDP estimate from 2.8% to 2.0%! How many more downward revisions like that can we take before sentiment shifts?
I have just finished reading a few of the latest weekly reports by the economics departments of some of the largest banks, and it is astonishing how they have dismissed the first quarter’s sharply lower GDP figures, the downward revised business investment and standstill of the housing market as consequences of the harsh winter. Come on! The center of gravity of the economy is no longer in the Northeast and MidWest, it is in the Sun Belt, and sure we had two days of ice and snow here in Atlanta, there were a few cold days in Texas, and a drought in California, but not enough to send even a ripple through the economy! And what about April, the start of the second quarter, when the consumer was supposed to come out of hibernation and carpenters could start swinging their hammers again on all the new homes under construction. How do they explain the fact that the growth of consumer spending in April accounting for 70% of the economy was actually negative in both nominal and real terms? The fact that sales of durable goods slumped well below expectations? And the only housing growth was in multifamily apartments accounting for only 17% of the housing market while applications for mortgages dropped to a 3 year low?
This herd behavior among economists and security analysts is worrisome, because once the data becomes overwhelming and they are forced by the sheer logic of the numbers to revise their forecasts, the herd is likely to stampede towards lower estimates. Fundamentally, I think the economy matters less to the stock market than Fed policy, and weak economic numbers makes it more likely that the Fed will continue its stimulus, but changed expectations on the economy would be a blow to sentiment that could derail the bull market in stocks at least temporarily.
The danger is nearby. Wells Fargo’s economists have bravely set aside all the negative economic data in their latest reports with assurances that it was caused by the weather, and that the economy, including the moribund housing market and consumers that are Wells Fargo’s life’s blood, would come roaring back during the rest of the year. At the same time however, the logic of the new data was so compelling that they were forced to revise their full year GDP estimate from 2.8% to 2.0%! How many more downward revisions like that can we take before sentiment shifts?
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