Remora
Gretchen Morgenstern's column this morning begins with the impressive run up in the stock market. She notes, as Rob Walker at Slate did on the 15th, that the market is up 20% over its post 9/11 low.

Here's a quote that is at the heart of her article:

"James Paulsen, chief investment officer of Wells Capital Management in Minneapolis, is of two minds on the recent rally. "Part of me says, how often does an equity investor have everybody from the Bank of Japan, the United States Congress, the European Central Bank and the Fed working day and night to get equities up?" he asked. "That's a hugely bullish thing to bet against. I don't disagree we're going to get a bounce and the recession will end, but I wonder how strong the recovery will be."

Mr. Paulsen is particularly concerned about the financial position of American consumers, many of whom have binged on borrowing and now face unemployment. Even though mortgage rates fell a few weeks ago, they have backed up again, reducing the potential savings from refinancings for many consumers."

Walker's piece mulls over a commonplace of Wall Street. Walker is too smart a fella to fall for it, but he does put the conventional wisdom in a nutshell (and you thought only oak trees and other vegetables could put things in nutshells, right? well, journalists put things in nutshells for Limited Inc to crack, with its big parrot like beak. So, don't ask any more tedious questions, or I'll throw some more cliches at you):

"One school of thought has long held that the stock market is not quite the reactive thing we often imagine it to be, but rather that it anticipates events. The crash of 1929, for instance, did not cause the Great Depression, but rather predicted it. One recent articulation of these ideas was the book The Message of the Markets, by CNBC anchor Ron Insana, published last year. One of the anecdotes in that book is Insana's recap of the market's reaction to the Jan. 17, 1991, launch of Operation Desert Storm. The Dow rose 105 points, and "the greatest bull market to ever take place on Wall Street got its start on the day the Gulf War began." Insana's point, and the theme of the book, is that while many experts at the time were predicting all manner of doom and gloom, the collective wisdom of the markets simply "knew better" and knew it sooner."

The idea that the stock market encodes information, and that that information is somehow predictive, is one of those nice ideological sleight of hands that tries to make a silk purse out of a sow belly future. In the last week, Limited Inc has been reading a history of the market, Toward Rational Exuberance, by Mark Smith. We found the parts about the early twentieth century pretty engrossing. Just as 9/11 seemed to signal the beginning of world disorder, and was followed by a equities suicide leap, the assassination of Archduke Ferdinand was followed by a market collapse. But in 1915 and 1916, American companies discovered the wonders of modern warfare. The money that flowed into American coffers was magical. If this happened today, what you would see is a bigger spread between price and earnings. What happened in 1916 was just the reverse. The ratio of the price of stock to the amount of the dividend went down, eventually hitting a historic low of 4 to 1 in 1916. Why? Well, this is one of the mysteries, kids. If we put on our explorer hat (a pith helmet, actually. We always write these posts accoutered - or would one say haberdashed? - in a pith helmet, but otherwise naked), we would have to venture into the psychology of expectation. In those days, those far off days, stocks were considered, with reason, to be a much higher risk than bonds. So the dividend on stocks had to be serious. So from the earnings end, that ate at the P/E ratio. At the stock end, there was the competition with bonds, which to the generation of 1910 seemed a much more secure financial instrument. This has reversed in our day, starting in the late fifties. That something like this can reverse is itself curious -- how does the horizon of expectation, which is a composite of different expectations, suddenly transform itself? And how are those expectations encoded into the price level of individual stocks? In spite of the Efficient Market Hypothesis people, it is hard to see where the market is getting its 'extra' information from. We aren't going to offer our own theory on this - we have delusions of grandeur around here, but we aren't crazy. But it does seem that traders, right now, are reading each others price levels much more than they are reading the extra-market indicators. In literature, this is referred to as post-modernism. In finance, it is the royal highway to a bust. Which makes sense - pomo is what happened when modernism, which tried to refer to everything in the world, all of history, the cavemen and the Minoans as well as aviation daredevils and occult fads, found that it couldn't. It couldn't cohere. So our advice to traders is: read the last cantos of Ezra Pound, those jagged fragments, and beware, beware.