— by Mitchell Clark, B. Comm.
The stock market is trading on sentiment — that’s it. This means that all prices are relative. So, when we get a big company reporting better-than-expected numbers, the numbers aren’t really that good; they’re only good relative to already reduced expectations. This is something we have to keep in the back of our minds as investors. The news still isn’t good — it’s only relatively good.
This applies even more so to the Main Street economy. The stock market might trade on some perceived good news, but most of this news so far still isn’t strong enough to get us out of recession. It only looks good, because it’s not as bad as it was previously.
The stock market may bounce significantly higher, but I think it will do so only based on sentiment, not on the fundamentals of the underlying economy. If this happens, it will set up investors for another big correction.
I’ve always been a bull on business. I believe in entrepreneurialism, capital markets, and free enterprise as the engine of technological innovation. For the first time in my business career, I’m not bullish on the future and it isn’t the fault of Wall Street, speculators or overpaid executives. This time around, the government is to blame on all sides. I know it’s easy to blame the politicians for everything, but from a financial policy perspective, everything seems to be going backwards in my mind. There’s too much debt, too much spending, and not enough regulation in the derivatives market. It is poor financial management that’s been years in the making.
When mortgage-backed derivatives almost collapsed the entire
global financial system, government took it upon itself to do all it could to help re-inflate an already over-inflated economy. In essence, through massive government spending (borrowed money for bailouts and stimulus spending), as well as money supply creation through the Fed (one big IOU in the future), the cost of the failure of billions of dollars of derivatives is now being transferred to future generations of taxpayers. The marketplace was not allowed to correct itself and the giant mortgage on the housing bubble is now effectively being shifted to individuals from over-leveraged financial institutions.
It’s going to take time, but the result of the poor financial regulation to begin with and the subsequent massive government spending with borrowed money is going lead to higher interest rates and inflation. All this at a time when unemployment is rising (less taxes to pay for all the spending) and there is increasing demand for entitlement programs due to an ageing population.
We have to fix the derivatives industry before the derivatives industry fixes us. This should be the top priority of policy-makers and it needs to be done on a global basis (the G20 at minimum). Government spending also has to be reined in and so do all the rosy promises. It’s tough medicine that’s required to get the system to correct itself. But without it, the problems will just get bigger and all we’ll be left with is relative good news instead of real good news.