2012 Second Half Outlook: Introduction: Psychology & Sentiment

2012 Second Half Outlook: Introduction: Psychology & Sentiment
2012 Second Half Outlook: Policy Response & How To Invest

I spent the first six months of this year, after posting the complete 2012 Outlook, discussing the triggers for the slowdown for the global economy that were out in the distance. I have focused a tremendous amount of writing on the European debt crisis and its impact on the markets. I discussed overvaluations in stock market prices (specifically America), as well as the danger of the sky high sentiment toward the future price direction of stocks.

While my readership continues to grow weekly (a sincere thank you to everyone who reads/contributes to this site), I notice that there are surges in viewership during days the markets sell off significantly. It is natural human psychology for people to see the market make a large move in a particular direction and immediately seek out a “reason” for that move.

The mainstream media understands this dynamic and they feed on it.  If you pull up the headlines on a website such as CNBC (I always pick on them because it is so easy), they will have articles such as “market is up today because home builder sentiment rises” or “market moves lower this morning due to fears in Europe.”

Trying to make investment decisions by watching what the market did on a particular day and then reading the media headlines is like driving down the highway looking through the rear view mirror.

While I spent the first half of this year tracking every tic higher in Spanish bond yields, tracking the deposit flows out of European banks, and tracking the global economic indicators rolling over every step of the way, most financial analysts, traders, and every day citizens (specifically in America) did not see any problems ahead. Why is that?

The American stock market was rising.

People seek out a reason to “justify” the move higher and mentally screen out the bad information around them. This is not a recent development - studies of both markets and psychology (one of my favorite topics to read about) going back over a hundred years shows this occurring over and over again.

The DOW fell close to 300 points in a single session this past Friday and is now down over 1,000 points since the beginning of May. The mainstream media headlines are now filled with same headlines found on this site four and five months ago (European worries, global economic data rolling over, etc). The media is now providing the "justification" for the stock market’s recent decline.

Back in mid March, I released an article titled Global Market Forecast specifically discussing the frothy sentiment in the stock market with a specific focus on Apple. At the time, Apple stock was being discussed relentlessly by analysts on television as it moved higher almost every single day.

A week later as the stock crossed over 600 for the first time, I wrote an article titled Apple Goes Parabolic, showing the chart of Apple moving in a straight vertical line upward. One week later, USA Today ran an article with the following headline: “Apple, Priceline, & Google race to hit $1,000-a-share mark.” In it they gush about the future direction of America’s new darling stock:

“It’s the new ego boost, to get a stock to $1,000,” says Jon Johnson of StockSplits.net. A stock’s price, by itself, doesn’t indicate how expensively or cheaply valued a company’s shares are.”

“As Priceline and Apple blow past existing price targets, analysts are making adjustments. Topeka Capital Research this week put a $1,000 price target on Apple.”

“Shares of gadget maker Apple, for instance, are up 54% this year. If that pace continues – something that many analysts say would be a tough accomplishment – the stock would easily top $1,000 by year’s end.”

Shares of Apple touched a high of $639 a week later and have collapsed down to $560 over the past 60 days.

While Apple topped out in April, many stocks in the overall market continued to move higher through the month. On May 1, after a massive and relentless four month run higher in prices, Alan Greenspan (the Federal Reserve chairman before Ben Bernanke) announced through the media that he felt “stocks were cheap.” Wall Street applauded Greenspan's approval and upped their huge end-of-year price targets, short interest fell significantly, and the sentiment indicators surged higher (all discussed along the way here on this site).

The stock market would top the day of Greenspan’s comments, and it has since become much “cheaper.”

People have watched the relentless flow of mutual fund money out of stock funds and into bond funds citing it as the number one reason why the markets should move higher in the near future. They look at this as “money on the sidelines,” but how does this stack up when you look at a longer timeline?

From 1974 through 1994, the percentage of households that owned stocks ranged between 23-36%. In 1980, shortly after the famous “Death Of Equities” cover, almost no American wanted to invest in the stock market. Today, after four years of steady withdrawals from the market, 53% percent of households are still invested in the market. The number topped out at 65% in 2007 (as the market was touching all time highs). This shows that the “average investor” still has a long way to go before sentiment reaches a normal or even pessimistic level. In the back of American minds, while currently afraid, they still have memories of the great 1980 to 2000 run as well as the recent market highs in 2007. It will take another "cleansing" move downward in order to truly bring back “The Death Of Equities.”

In the following sections we will review how the global economy and financial markets have changed over the past six months since my initial 2012 Outlook was released and discuss where markets are likely to move from here.