Climbing a Wall of Worry — John DeTore

MIT Sloan Sr. Lecturer John DeTore

The U.S. stock market is now at new highs. So why are average Americans continuing to struggle and not feeling this prosperity? What causes this apparent disconnect between market highs and citizen well-being?

As the expression goes, stocks are climbing a wall of worry. And by our estimates, despite economic malaise, the stock market hasn’t peaked, and we’re still on the way up. Here are some reasons why:

  1. The market largely reacts early in the cycle (and just remember: We are largely no higher than we were at the 2000 peak);
  2. We’re stimulating the market fiscally with low interest rates for some time to come;
  3. Businesses have cleaned up their balance sheets after the financial crisis and are now liquid (in fact many are sitting on huge cash reserves); and
  4. Companies are finding ways to achieve higher earnings despite a difficult political and regulatory environment.

In fact, strong availability of capital (very low rates and available cash) and labor (high unemployment) make managing and growing businesses easier.

Unemployment, though, is improving slower than we would expect given where we are in the recovery. In each recovery it is the same: Boosting profits comes first; hiring only occurs when managements fear falling behind their competitors in opening new products and markets. But the effect is more pronounced this time – it’s as if they are afraid to expand. Look at how dramatic this is for the current recession:

The patterns for past recessions were roughly symmetrical: If 4% of the population lost their jobs over two years, you’d see a 4% increase in employment in the following two years. This is the first time we’ve seen an asymmetrically weak recovery in employment since the Great Depression. We’re still talking almost 8% unemployment. That number would be higher if we consider the underemployed.

One cause of the poor employment recovery is the political environment. The rhetoric on the part of President Obama, a lack of cooperation in Congress on the part of both parties, all combined with confusion over regulations in health care, financial regulation and our tax policy slows hiring. Surveys of business leaders confirm that. Message to political leaders: We need to start with hope and a pro-business attitude. Then the recovery fuels itself: Better outlooks lead to investment, more economic activity and even better outlooks.

Eventually, when all businesses are growing, all excess capital deployed, all cash reserves productively used, and all people who want a job are employed, it is a beautiful thing psychologically. But it is also a sign of a market peak.

Yes, markets climb a wall of worry. The converse is a “feel good environment,” which is the sure sign of a market peak. Just remember, markets bottom when the outlook is bleakest, but peak when everything is swell. The good news for the stock market is that everything certainly doesn’t feel swell, yet.

John DeTore is a senior lecturer in finance and the chief investment officer for GRT United Alpha.

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