In this week’s MarketShadows Newsletter:
- Consumer habits, spending
- Housing market
- Springheel Jack on AAPL
- Chris Vermeulen on Gold
- Pharmboy’s stock ideas
- Reports from Sabrient
- Cognitive Dissonance in the Stock Market
Consumers make up 70% or so of the economy, and consumers have been saving more and spending less. In an extensive analysis, Tony Pallotta at SafeHaven argued that "The Consumer Has In Fact Changed." While this change in consumer behavior on the surface may look good, the underlying situation is less encouraging:
“Since the ‘end’ of the 2008 recession something very interesting has happened to the US economy. US consumers have actually changed their spending habits. They have actually started to live more within their means. And that is a very positive sign for a number of reasons both financially and socially.
“Yet it has been masked by one very dangerous action. As the US consumer has pulled back the government has tried to make up the difference through an explosion in government debt.
“The charts may point to income growth, showing the consumer is fully recovered from the great recession. But they are misleading. The consumer is in damage control mode. It is government spending which has fueled this growth, a misleading term. It is this explosion in debt that is masking the truly fundamental and structural shift in the economy.”
Given a fixed income, increased prices for essential items reduces spending on nones- sentials. Therefore, if increases in income are matched by higher prices for food and gas, there is no left over capacity for more spending. Demand for discretionary items decreases; spending levels off. (The Consumer Has In Fact Changed)
The price of staples, essential items such as food and gas, have been increasing over the past few years, eating away at the disposable income (regardless of government reported “inflation” numbers which do not adequately represent prices on essentials).
Gasoline is one staple that causes wild swings in disposable income. AAA illustrated how driving habits are altered when gas prices are high in the graph below.
Even with the price of staples drifting higher, Federal Reserve Chairman Ben Bernanke is determined to alter the mortgage landscape and drive interest rates down to historically low levels. Mortgage rates on a 30-year loan are at record lows, e.g., 3.6 percent in August 2012. This is down from 6.1 percent at the beginning of the recession in December 2007.
The Fed’s latest quantitative easing operation (QE-Infinity) is structured to keep rates lower by continuously supplying money to the Primary Dealers to buy mortgage backed securities (MBS). The Fed’s buying has prompted institutional investors to bid up the price of mortgage bonds, thereby pushing down yields. The yield on the MBSs—the effective rate that new investors receive— fell to just 1.01 percentage points above the yield on Treasuries. That was the narrowest spread in almost 15 years, signaling that investors are demanding only a small premium to own mortgage bonds instead of Treasuries. This artificially reduced price for risk reflects the Fed providing a safety net under the MBS market.
The desired effect is to make people (particularly home buyers and homeowners) feel and act richer. Lower rates also inflate the underlying asset prices--homes in this case. Lower mortgages give homeowners more disposable income so they can spend more money. Spending more money on goods can affect manufacturing, increasing economic activity, and so a ripple effect begins...
...AAPL is starting to look interesting as a long again. On the daily chart, the 100 dma broke at the second test on Friday, the H&S target is in the 590-600 area, and the main target is a test of the 200 dma in the 580 area. A good entry would in the 580-5 area. In a bullish scenario, there would be a strong reversal back up from there.
On the long term AAPL chart, there are five previous retracements in the last 20 years on strongly negative weekly RSI divergence like this retracement. While the last retracement was about 15%, the next smallest retracement was 42% in 2006. (Long term AAPL chart is here.)
AAPL may fall further. There are two possible H&S necklines below in the 567 and 520 areas. I favor the higher 567 area neckline as it fits with a drop into long term rising channel support on the log scale chart around 400. On a bounce from the 520 or 567 areas, I would be looking to exit in the 600-640 range:
As long as AAPL holds its 200 dma area, it could be a straight long play from major support (around 580). Apple Inc. is a company with a great market position and an unusually low historic P/E ratio in the 14 area. Sabrient rates it a strong buy – read the Sabrient report here.
The economy and the stock market are not in a direct cause and effect relationship. There are many variables and confounding factors affecting the health (or appearance of health) of both. There are also enormous issues of measurement – how do you measure economic conditions? Which factors matter, and to what extent? Which yardsticks are most meaningful? Which are not meaningful at all? And highs in the stock market may look good at a distance, but the measure is in money. Inflated money due to money printing is not an underlying signal of health, pretty chart patterns aside.
So when trying to anticipate the direction of the stock market for purposes of making decent investments (in an environment where the value of the Dollar can be expected diminish), it may be a mistake to get too overwhelmed by long-term predictions that the economy is in a perpetual state of decline. Even if you agree with those predictions.
From a psychological perspective, “cognitive dissonance” describes the state of holding two or more conflicting cognitions (e.g., ideas, beliefs, values, emotional reactions) simultaneously. According to the Wiki entry, “The theory of cognitive dissonance in social psychology proposes that people have a motivational drive to reduce dissonance by altering existing cognitions, adding new ones to create a consistent belief system, or alternatively by reducing the importance of any one of the dissonant elements.
“An example of this would be the conflict between wanting to smoke and knowing that smoking is unhealthy…”
Or let’s say, believing that the stock market should go up based on the Federal Reserve’s undeniable love of money-printing and the perennial Bernanke Put may conflict with the notion that our country has entered a long period of decline by measures such as wealth (for the 99%), equality and opportunity. Those beliefs might invoke uncomfortable feelings of cognitive dissonance. In his book “When Prophecy Fails,” Leon Festinger (who coined the phrase “cognitive dissonance”) chronicled the thought processes of followers of a UFO cult “as reality clashed with their fervent belief in an impending apocalypse…”