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Market Facing Bigger Headwind Than Washington, Says Hersh Cohen

Jeff Macke
Breakout

As the government plays Hamlet with the nation's economic future, the stock market seems curiously unconcerned with whether default is to be or not be. Stocks pulled back 4% from record highs but once the S&P500 (^GSPC) neared it's 100-day moving average buyers came calling. On Tuesday the S&P500 closed at 1,698, almost dead flat for the last month.

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The paradox between the performance of the stock market and the damage being done to the American economy is nicely summarized in a Gallup poll released yesterday. For the week ending October 13th Economic Confidence slide to the worst levels since 2011, dropping 5pts for the week after 22pt slide during the first week of the government shutdown. Regardless of this the Consumer Discretionary Select Sector SPDR (XLY) flat-lining near all-time highs despite sentiment continuing to plummet.

Related: Debt Deadline Approaches: Here's What Happens if U.S. Defaults

Hersh Cohen, co-chief investment officer at ClearBridge Investments, thinks the lows have been made, at least for the time being. But psychology is the biggest risk for short term traders if a "sell-the-news" reaction in the event a deal is struck at the 11th hour. "We'll probably struggle higher here, maybe even make a new high," Cohen says in the attached video. "The real problem here are revenues and earnings... the market's up 17 or 18% this year and earnings are up 6%."

The combination of earnings lagging market expansion is called "multiple expansion." In effect stock market investors are paying more for each dollar of earnings. The end game in multiple expansion stories is either earnings catching up in a hurry or stocks falling.Cohen thinks the slow rate of earnings growth isn't the result of anything the goverment is doing, but the lingering impact of the Great Recession. With consumers still hanging on by their fingernails, revenues at companies he watches like Target (TGT), Wal-Mart (WMT) and United Parcel Service (UPS) are better than terrible but no where near good.

The elephant on the trading floor is Washington, DC; the biggest question for short and long term investors alike is "what happens after Thursday?"

Ultimately all investing comes down to probabilities no matter what professors try to tell you in finance class. "I think the odds are probably 60% that you get a 'chase the market' (reaction)," says Cohen, quickly adding that he's not one to buy stocks as they rip higher.

"I don't think you should be worried about whether the market rips up or comes back in in the fourth quarter," he says, "obviously unless they don't reach an agreement on the debt in which case you have a catastrophe."

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