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Thursday, March 27, 2008

Inflection Point Defined in Stock Market Context

What is an inflection point, or point of inflection? Well, do you ever feel as if the stock market has the personality(ies) of Dr. Jekyll and Mister Hyde? Don't panic, the chaos actually makes perfect sense. At times like these, points of inflection, the market is sure to have mixed emotions and for good reason.

I can almost hear the burly traders speaking in their Brooklyn/Queens tongue now. I hear them complaining to their wives after arriving home from a desperately needed after work beer with the boys, "this market is like Dr. Jekyll and Mister Hyde!" One day we're positive and hopeful and the next day we're back down in the dumps.

But don't fret, we need not rush Mr. Market to Bellevue, America's oldest public hospital that is perhaps best-known for its mental health program. He does not need a psychiatrist. Like most troubled souls, all he needs is time to see and understand his problems as logical consequence and progression.

Inflection points are by definition points of directional change, or according to my dictionary the point where a curve changes direction. I believe the topic is best studied non-specific to second, hour, day or week. It's too difficult to be that precise in the pegging of its arrival. However, like any point of measurement on a timeline, we reach it in apparent linear or non-linear fashion, depending on the time period used as the basis for measurement. For instance, if we study monthly data, the trend should look more linear than if we look at it on a per minute basis.

So in other words, the market only appears to suffer from multiple personality disorder when we study it on a short-term basis, like daily. Years from now, economists will look back at this period using monthly stock market index price points, and they will find it quite easy to see stock market and economic trend. They will likewise easily note the market's true inflection point.

Good News Bad News

At inflection, the market is barraged by mixed messages on a daily basis. At this particular inflection point, which would be one reflective of economic trough (hopefully we're there), the messages are completely different than those at economic peak. The federal government, including the Federal Reserve Bank, the Treasury Department and Congress, has taken substantial action to spur economic expansion. That's the good news, offering reason for stock price appreciation, and hope.

At the same time, the real economic data trend is one representative of deterioration. The news flow is getting worse, not improving. Even so, we've yet to record a quarter of economic contraction. If you play stocks by the economic book, you would still be months away from taking long positions.

However, Mr. Market does not play by the economic book. He's much more complex than that. He's what's called "efficient" in university lecture halls the world over. He absorbs all available information and prices it. He weighs reported facts at face value and their future implications employing probabilities. In other words, he considers Wednesday's reported durable goods orders at face value. At the same time, he knows the Fed's actions should help spur economic growth, and he weighs the probability of how much benefit will come versus harm (inflation) and when it is most likely to arrive. This helps him estimate where durable goods orders, and other economic measures, will rate months from now. Both these data points, present and future, play a role in the market's pricing of securities. Of course, non-economic related industry and company specifics play an important role for each individual security as well.

The point is that while economic data flow and news seem dire now at the point of inflection, and short-term trading reacts to it, the market is at the same time weighing how government and private sector actions might drive future economic conditions. This stew of data is simultaneously pricing securities, and should start to lead the stock market higher well before economic conditions are reported improved. So, don't get lost in the mayhem of the minute. Be aware that you will fight a wall of worry on your way to capital gains, and never more so than at the inflection point of economic trough.

Come back to The Greek every night for the "Daily Market Wrap," our video piece to help you catch up on the day's news. For Readers: AMEX: SPY, AMEX: DIA, Nasdaq: QQQQ, AMEX: SDS, AMEX: DOG, AMEX: QLD, NYSE: NYX. (disclosure)

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Anonymous Tim@Daily Money Tip said...

Great article today. I think if you are investing for the long-term and are a "buy and hold" investor (which I'm not), today's market looks like a descent entry point. I'm a bit more pessimistic about our economy and fear Mr. Ben might be doing more harm than good in the long run. I'm staying patient and I'm only lightly invested as I've been since the beginning of the year.

What's your "official" opinion on the short term market ... say the next 1-3 months?

This market feels a lot like our last recession of 2001 where everyone always tries to call the bottom every time the Bulls make a little run. I'm not biting, yet.

3:56 PM  
Blogger Uncle said...

Hey Greek,

My wife, before we were married, went to Graduate School, and paid for her tuition through student loans. She thought, as the Columbia financial aid dept. explained to her, that these were all federally subsidized loans and would be at a manageable interest rate of between 3-4%. Under those stated facts she took on this debt. Upon graduation, she learned that most of these were in fact private loans at a much higher interest rate of 8-9%, which obviously make the repayment amounts much higher. As you and many other Politicians these days are proponents of bank bailouts and homeowner bailouts---when will the government start bailing out students who took on debt under misleading terms to finance their education. Are we drawing a line in the sand stating that homeowners are of greater importance to the American economy than educated americans? What about car owners? The list goes on my friend. Let the invisible hand of Adam Smith work out the issues in this supposed Free Market. Oh, I forget, it is only free when the million dollar bonuses are being paid out to the finacial geniuses ('eh wizards) of Wall Street.

5:17 PM  

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