By Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University
In each of the past four years, any advances in the U.S. equity market that occurred in the first quarter (as is happening now in 2013) have been more than reversed by deep “corrections” in market values that come on with the fury of a March wind with the onset of spring.Whether it was the Federal Reserve’s premature (although pre-scheduled) termination of its first round of mortgage buying (restored after a few months and pursued to this day) in 2009, or the onset of the re-emergence of the Greek/Euro financial crisis in 2010, or the opening acts of the US debt ceiling crisis in 2011, or the re-emergence of the Greek crisis, spread to Spain and Italy, in 2012 – the result was always the same: A swoon in stocks in the spring. The old saying, “sell in May and go away” was replaced by, “May’s too late, buddy” as stocks hit lows on their way to summer.
Where the Money Is Being Made
Each year, however, those who bought while the correction bottomed reaped large rewards by autumn as a combination of political fixes in the U.S. and Europe (aka can kicking) and Federal Reserve market interventions pushed and pulled stock prices back up to the point where, in 2012 for instance, the S&P 500 equity index finished up 16% for the year! Needless to say those who bought in the spring trough were up way more than 16% percent for the year.
Fool me once, it's your fault. Twice, it's my fault. But four times? Ever feel like the can that got kicked down the road? Do we sense a pattern here?
For the past four years, it has been possible for professional traders to employ various “tools” to manipulate the market down to their advantage – first to generate profits from their “short” positions, and then to buy stocks they have driven down on the cheap side.
First, it was stories planted in the media about how foolish Federal Reserve policy was going to bring on rampant inflation in the U.S. – that hasn’t happened. Then it was the firm conviction of commentators that Greece was going to have a messy default and leave the euro (these still continue, although Greece is still there), or that Germany would leave the euro (still there), or that the euro currency itself would drop to parity or worse against the U.S. dollar, or even collapse totally (it’s still there, trading well above parity).
As it happens, the Financial Times of London has just reported that a net $100 billion in private investment has poured back into the wounded periphery economies of the Eurozone in the past year – equal to a nine percent boost to the economies of Greece, Spain, Portugal, Ireland and Italy. All is not yet fixed in Europe, and there is much hard political work to do, but Armageddon has slipped off the horizon.
Then there were the firm predictions that the U.S. would default on its debts, or that we would go over the “fiscal cliff” – we didn’t. In 2012, “analysts” firmly asserted that S&P earnings would be down in each fiscal quarter of the year – they were up in every quarter. Most recently, the same “experts” predicted that revenues would be down for the last quarter of 2012 – but thus far, 65% of the companies reporting show revenues up!
And then there is Apple (AAPL). one commentator went so far as to opine that Apple was now a broken company (just days after the company reported the largest revenue ever reported in one quarter by a technology company). One can argue about Apple’s competitive challenges and supply chain hiccups, but to call it a broken company is hyperbolic in the extreme.
But bear in mind that a bear run on Apple benefits many market players – especially the investment banks that sold one-year high yield notes to investors that repay them not in dollars but in shares of Apple. If Apple's price has declined significantly from the issue date of these notes (which have a face value equal to the price of Apple stock on the notes’ issuance date) then the banks make a lot of money on the deal. A note priced at Apple's former price of $700, even at 8% monthly, would pay out $56 in interest. But if Apple’s shares stay at $450 until these notes mature in just a few months, the issuing banks will pay back $250 less than they borrowed – a 35% profit!
It's About Perspective
This little example just goes to show that it’s important in this market to recognize that not all the naysayers and analysts are disinterested observers. Facts are stubborn things, but they can get drowned out in the torrent of negative sentiment, especially among ordinary investors who do not routinely “short” stocks either directly via derivatives and option positions, and thus don’t realize that market Cassandra’s or no more credible than Pollyanna’s.
Market manipulation downward has thrived in an environment where pessimism has becomes fashionable. Market seers who kissed the mortgage meltdown try to win book contracts by predicting the next “black swan” event – but when everyone sees black swans on the horizon, they’re no longer rare – or credible.
Pay Attention to the Data
Despite the emerging good news on the U.S. economy – significant housing recovery (prices up 5.5% in November, the biggest jump in five years), continued low inflation, steady reductions in weekly unemployment claims, cash-flush corporations, solid bank earnings, increased business lending – there are many hedge funds who bet short on the market for the start of this year, and now have a bad case of performance anxiety.
Investors should remember that there are two cures for this hedge-fund ailment: playing catch-up to the market (which can get expensive) or try to “talk the market down” to their level. The latter tactic worked rather well for the past four spring seasons, and even again early last autumn. It will pay a lot of dividends in the coming weeks to pay more attention to data and facts than reports of black swan sightings.
Many good reasons may emerge in the coming weeks – government shutdown, sequester debates, Mideast unrest, oil prices, Italian politics – that would warrant a stock market correction as we leave winter behind. But none of these events necessarily means a new Armageddon. And the fact that the market tanked in spring each of the past four years does not prove “Chicken Little” is finally right this time, after four years of being ... well, wrong!
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.
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