The following headline caught my attention over the weekend: American Stock Markets Are Surging, So Why Do Americans Feel Like It’s Still Recession?
I was hoping to open the article and read about the need for investors to understand the difference between stock markets and the economy. I was hoping to read that traders react to headlines, while long-term investors don’t. I was hoping to read that markets aren’t going to wait around until people feel better to revert to more realistic values…either up or down.
Instead, the article touches on the concept of investor confidence, suggesting at one point that it plummeted as a result of the Great Depression, but then suggests in the next paragraph that falling investor confidence actually caused the Great Recession.
This article provides a perfect example of how easy it is to get suckered into using the same data to support two completely different opinions. On one hand, investor confidence may provide an interesting talking point in the world of short-term market movements, but has very little bearing on the economy. On the other hand, a long-term investor is going to process that data in a much different manner than a trader. This gauge means something completely different to each of these market participants.
At the end of the day, it still feels like a recessionary period because relative to life in 2007, it is! It may not meet the economic definition of recession, but the economy remains pretty sluggish, unemployment remains high, the housing market is nowhere near 2007 levels, incomes are down, and state and Federal budgets are pumping out more money than they are taking in. At the household level, the lifestyle of many American families has not recovered to the level it was in the mid-2000’s…and the unfortunate reality is that for many of those folks, it probably never will.
People inherently have an anchoring mechanism that seems to remember high points as “normal,” and every comparison moving forward is based on that reference point. Americans still feel like we are in a recession because we have not returned to the “glory days” of a half decade ago. Until we re-calibrate our mindset to accept that our lifestyle today is closer to “normal,” we are going to feel down.
At the same time, markets are up because they function independently of the economy and don’t care. As Benjamin Graham stated, “in the short term, markets are a voting machine, while in the long-run, they are a weighing machine.” Investor confidence can impact the short-term fluctuations in the market, but over time, markets will ultimately revert to true value.
We must remember that stock represents real ownership in real companies. Further, if you add up the total value of all of a company’s stock, it should theoretically represent the total value of the company. If we treat it that way, we can begin to understand how ridiculous it was for the value of multinational companies to “lose” over 50% of their value during the 2008 – 2009 downturn. Investor confidence (or lack thereof) may have caused the prices to fall, but they certainly did not change the overall value of these companies.
In a recent white paper, The Seven Immutable Laws of Investing, James Montier stated that “valuation is the closest thing to the law of gravity that we have in finance.” If we are patient as investors, market prices will ultimately reflect the true value of a company. When times get tough, companies will make adjustments – slow production, downsize, lay people off – and do whatever it takes to survive. Unfortunately, that sometimes comes at the expense of the economy, but all the more reason to be sure you separate the two.