Are Markets Always a Discounting Mechanism ?

Wednesday, October 03, 2007 | 10:18 AM

On Kudlow & Company last night, Doug Kass and Larry got into a debate (with Art Laffer refereeing) as to whether markets are a true and reliable discounting mechanism.

Kass' position was that they are often not. I am found of saying the market was as wrong at Nasdaq 5000 in March 2000 -- earnings didn't matter, its a new paradigm -- as it was with Nasdaq at 1100 in October 2002, when profitable debt free companies were selling ofr les sthan book value, and in some instances, less than cash on hand.

Shedding some light on this is David A. Rosenberg, Merrill Lynch's North American Economist. Rosenberg looked at whether a recession could begin with equities at or near all time highs.

The answer, surprisingly enough, is yes:

"The S&P 500 peaked on July 16, 1990 after a 3.4% burst over the prior month and the recession began that very same month.  Go back to February 13, 1980 and you will see that the market peaked and came off a huge 7.8% melt-up in the previous month – and the recession had begun the month before. . .

What we do know is that the economic backdrop has become worse, not better.  Over 90% of the economic data have come in below expectations in the past month and our internal Data Diffusion Index has hit its low-water mark for the year . . . "

Stock markets are not always perfect discounting mechanisms:


Source: Merrill Lynch, Standard & Poors


As Jack McHugh points out, many investors seems to think a recession would either be bullish (because the Fed would continue to ease) or would be an impossibility (because the stock market, "discounting mechanism" that it's supposed to be, is hitting new highs).  And he notes that markets also peaked in 1929, even though the highs were seen a couple of months before the onset of the Great Depression. 


"I suppose it's possible that the price-worshiping, momentum crowd has it right and that nirvana lies just over the horizon.  Given the worsening problems in housing and mortgage finance, however, it's possible, just maybe, that the quantitative model-builders in equity land will prove to possess no more genius than their fixed income cousins displayed when constructing subprime CDOs."

Discounting mechanism, indeed.

Wednesday, October 03, 2007 | 10:18 AM | Permalink | Comments (57) | TrackBack (1) add to | digg digg this! | technorati add to technorati | email email this post



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Tracked on Oct 10, 2007 10:20:32 AM


I was reading Devil Take the Hindmost a few months back and the author points out that traders in 1929 kept pushing prices higher not based on what companies were doing now, but what people believed they would do in the future. Then I happened upon an article yesterday by Jack Schoen observing that traders currently are trading not based on current economic conditions but on what they believe will happen in the future, say a year from now. Funny, that.

Here's Schoen's article if you're interested:

Posted by: Florida | Oct 3, 2007 10:51:27 AM

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